How to Size Your Investment Positions
If you are following along with the learning program I have set out for new investors, you are now neck-deep in the topic of portfolio management, including allocating capital, creating buying programs, sell disciplines, and managing correlation. In this article I discuss the topic of position sizing and how to keep it simple and repeatable.
Position sizing is a critical part of risk management and capital allocation. Rather than talk in terms of theory, let's jump into the topic with some concrete suggestions.
The actual size of the position you take will depend on your preference for concentrated investing versus diversified investing. For new investors, I would recommend not having fewer than twenty positions at full commitment, and for each of those positions to be in different industries.
This accomplishes a few things.
First, it will force you to do valuations on at least twenty companies before you can be fully invested.
Second, it will force you to learn about at least twenty industries.
Third, each position can only be 5% of your total portfolio, so if you make a mistake, it won’t destroy all your capital.
I also insist that new investors should consider 30% of their total capital be called “reserve cash” and is to be untouchable until a market correction.
That leaves 70% of your portfolio that needs to be allocated across your best investment ideas. With the rule that no position can be greater than 5%, that leaves a maximum number of positions (initially) of 70/5 or 14 positions.
If you started with a pool of capital of $100,000, each position at maximum, would be $5,000. You would then set up a buying program such that the full $5,000 per position would be invested over a period of a year or more, to take advantage of opportunity cost.
If your buying program was once a month, over a period of twelve months ( a pretty good program), then you would be buying $417 per month per position ($5,000 / 12).
That is position sizing in a nutshell. Now, the chances are good that you will not be starting with exactly $100,000, so you need to set up a position sizing calculation for yourself.
You can do the same math I did in this article on the back of an envelope or lunch receipt. If you are nerdy like I am, you use Microsoft Excel and set up spreadsheets to do the math for you.
Don't get too tricky or complicated with your position sizing. Keep it simple. Once you do the math the first time, adjust it once a year to incorporate changes in your pool of capital.