My Royal Bank stock has doubled. Should I take some profits, or let it ride?

I have the very fortunate situation of owning some bank and insurance stocks that have more than doubled in price since I bought them, giving me a large unrealized gain. There is much debate among my investing buddies about what to do next. Is it wise to take some of that unrealized gain by selling these stocks and reinvesting the proceeds in another dividend-paying blue-chip? For example, I could sell some of my Royal Bank (RY) and put the proceeds into Bank of Nova Scotia (BNS) or Toronto-Dominion Bank (TD). Doing so would increase my dividend income and may produce a better gain as both banks are beaten up. Or should I just stay the course?

Sitting on a stock with a large gain is a nice problem to have, and one that many investors may be wrestling with after the stock market’s strong run over the past year.

As much as I’d like to give you specific advice, it’s not possible based on the limited information you provided. That said, here are some questions to consider that may help you come to your own decision.

How big is your position?

Generally, the main reason to consider trimming one of your winners is to control your risk. To take an extreme example, imagine Royal Bank rose to the point that it accounted for 50 per cent of your portfolio. Your future returns would depend largely on the performance of that one bank. That’s great if Royal Bank, which has posted a total return of more than 50 per cent (including dividends) in the past year, continues hitting it out of the park. But if it stumbles badly, you’ll pay a hefty price. As wonderful as our banks are, they are capable of screwing up, as TD’s money-laundering fiasco illustrated.

Intuitively, most people would agree that holding half of your capital in one stock is too risky, and in such a case it would be prudent to cut back to improve your diversification. But this is where things get a little trickier. Would a weighting of 20 per cent be acceptable? For most people, that’s probably still too high. What about 10 per cent? Maybe, if you had a strong conviction about the company. That leads us to question number two.

How confident are you?

I just peeked at my personal portfolio, and my largest single-stock position is the gas and electric utility Fortis Inc. (FTS), with a weighting of 7 per cent. That doesn’t bother me in the least, because Fortis is a well-managed company with a long track record of growing its earnings and dividends. What’s more, Fortis provides an essential service, and its returns are regulated, making it not just the largest, but one of the most predictable, stocks I own.

If your Royal Bank position is similarly in the single-digit range, there may be no compelling reason to trim. On the other hand, if it accounts for, say, 10 per cent or more of your portfolio, there may be a case for cutting back. As you can see, there is no hard-and-fast rule here; the idea is to control your risk, taking into account your conviction level for the stock in question, and remembering that no stock is completely risk-free.

How diversified are you?

Now, if Royal Bank is your only Canadian bank, it might be prudent to allocate some capital to TD, Scotia or one of the other big lenders, keeping in mind that there are no guarantees that these banks will outperform Royal Bank. Doing so will improve your diversification and, depending on which bank you choose, increase your portfolio’s dividend yield. Royal Bank currently yields just 3.2 per cent, while TD and Scotia yield about 5.2 per cent and 5.4 per cent, respectively. Before you take any action, however, consider the next item on this list.

What sort of account is it?

If you’re investing in a registered retirement savings plan, tax-free savings account or other registered vehicle, selling one of your winners will not trigger any capital gains tax. That’s a big plus. In a non-registered account, on the other hand, you’ll have to report the gain on your tax return and fork over some dough to Ottawa (assuming you can’t offset the gain with capital losses). If it’s an especially large gain, your tax bill could be significant. For this reason, I am generally less inclined to trim winners in a non-registered account, as long as I remain confident about the company’s outlook. So, you’ll have to weigh the money, if any, you would lose to taxes if you sell against the diversification and yield benefits of rebalancing. For me, letting the stock ride usually wins out in such situations.

Are you focused on the big picture?

You know the saying, “Can’t see the forest for the trees”? Well, think of Royal Bank as a tree, and your portfolio as the forest. More important than deciding whether to trim your Royal Bank position is to make sure your entire portfolio is adequately diversified. You can accomplish this by choosing high-quality stocks from a range of industries. In my own portfolio, I hold more than 20 individual dividend stocks – including banks, insurers, power producers, pipelines, consumer stocks and real estate investment trusts – which I supplement with broadly diversified Canadian and U.S. index exchange-traded funds. The overall composition of your portfolio matters much more to your returns than the weighting of any single company, so focus on the big picture before you start micromanaging the details.

E-mail your questions to jheinzl@globeandmail.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.