After following stocks in your pipeline, you will find one that deserves an actual investing position. Tony Morgan describes way to do that without upending your existing portfolio (or your sleep patterns)

This is kids’ stuff, but more than worthy for adults pursuing the investment game.

'Baby stepping' is an investment strategy, a strategy that can be applied either if you are beginning investing or if you are a pro. Its beauty lies in its simplicity and agile capacity as a tool for navigating your portfolio in the right direction.

The wording, 'baby steps' gives an obvious clue to what it is all about. You use small steps in buying stocks that are part of your pipeline of ideas.

Why small steps

Okay for a new investor this is a no brainer. With limited knowledge probably on your first investment it is wise to just use a portion of funds available. This is so, because as a little time passes, say three to six months’ minimum, you’ll get more feedback from the market whether how your investment is going the way you intended. There will probably be a least one result (half or full year) from the company, so the outcome from this result for example should be correlated somewhat with the share price and thus you’ll get that feedback loop generated. Was your initial investment decision okay?

For a first-time investor, getting runs on the board, i.e. not being traumatised because your initial foray was stupid, will be somewhat mitigated if you had taken a moderate approach, that baby step, step.

The 'baby step' strategy has its use in managing an uncertainty world.

Another way of looking at the idea is like this. Let’s say I want to add another stock to my portfolio, because I have just found a stock that I like, either firmly within my pipeline (like sitting there for a year or so, but it say had taken me so long to come to grips with its business, valuation etc.) or I’ve suddenly come across this company and want to buy some shares.

Either way, should my judgement, my thoughts suggest still (an uncertainty anguish), at this moment, I should only just nibble at buying some stock (I could also be short of funds) to get me started.

In fact, I did this the other day on a US company Quicklogic (QUIK). Our group, the Shephard, Silver Fox and me, have been talking about this small cap fabless developer of embedded Field Programmable Gate Array (eFPGA) hardware and sensor software for about two years. This small company is on a turnaround, but its actual technology is rather technical, but for consumer markets quite relevant (in wearables, like ear phones for example). And since it is still unprofitable, I am loath to lay down lots of cash.

But at the same time the share price has recently retreated almost 40%, so because of this and because we have some understanding after monitoring it for two years, a small position felt warranted. I took a 'baby step' position.

The actual size of that initial position in dollar terms is irrelevant. What is relevant is how big a percentage it is versus your current investment portfolio and funds available to be invested.

So in my case, the QUIK position is very small compared to my total portfolio. I am very comfortable taking a tiny stab, finally getting a position, because I like the idea, but also because the game it plays (let’s say an emerging player in edge imbedded technology) will take, what I think, much time to play out (by my reckoning another 12 mths or more), before I will know I am on to a winner or not. If the latter occurs with my current small investment, then I will not be to perturbed. At the same time, the 'baby step' has given me a real position, some skin in the game. If in the future I become more knowledgeable about the company (you would hope so!) as time passes, it may give me a chance to add to the position, should the opportunity present itself.

The discipline is not to chase too many 'baby step' positions as you will dilute your ability to understand each investment (again that rule of seven), however like me, should you have many ideas, even if you go over this preferred diversification number, a 'baby step' plethora of stocks won’t kill you. At worst, you might be down on a whole bunch of bummers, but you’d have learnt a thing or two in the process, without being mortally wounded, monetary wise. The 'baby step' strategy in general terms is there to help you through that zone of uncertainty. 

At its best, baby steps will lead you up the mountain to the ultimate potential investment, an investment where you have finally decided to go for broke, where you have learnt so much over X amount of time (and this may be years and years, could be 20 to 30 years for instance) that a substantial investment is made into your best idea (and of course where funding is available).

The Stud

My son has finally taken his first leap into the dark, investing thereabouts $1000 on four positions. These are:

• Facebook, (a FB fain obviously)
• Pfizer, (cause their mRNA Cov19 vaccine is minting money)
• Sky TV, (a turnaround story)
• Vanguard S&P 500 ETF (just to keep the script going that it is tough outpacing Mr Market)

Now in one respect he is taking a 'baby step' approach. He will have many more funds to invest over time (keep working (and saving) boy!), thus I suspect he will add to each position over time as he thinks best (and/or diversifying further).

He could have just invested in one stock or index fund, but he didn’t. That decision in itself has already given a glimpse into his investment philosophy. He is quite determined it seems to take a moderate, mature view on investing. Quite astonishing, but pretty cool. Nice and easy. A good mix to begin.

From these humble beginnings, he should do well enough, succeed in building a sensible long term investment portfolio that performs sufficiently well and that enables him to sleep well at night. Good start, son.

Tony Morgan has run a portfolio management business and an equity brokerage, both of which were purchased by Craig Investment Partners. He now runs a small family office that invests globally. Other articles in this series can be found here. And the profiles of all the NZX50 companies can be found here.