Determining How Much to Allocate to Each Investment
The influence any single investment has on your overall portfolio’s performance depends significantly on its position size. Position size is the percentage of portfolio dollars allocated to a specific investment, such as a stock. To use a simple example, say an investor has a $100,000 portfolio invested in 20 stocks. Under an equal-weight scenario, each stock would have a position size of 5% of the overall portfolio’s value. In other words, $5,000 would be invested in each of the 20 stocks.
Focus on Dollars, Not Shares
Notice how the number of shares is not discussed. When allocating, focus solely on the amount of dollars and not the number of shares. If you focus on shares, you could end up buying 100 shares of a stock trading at $20 and 100 shares of a stock trading at $50. The dollars at risk are $2,000 and $5,000, respectively—a big difference. If you allocate $5,000 to each stock rather than being concerned with how many shares you are buying, the amount of money at risk is the same for the two stocks.
Going back to the original example of a 20-stock portfolio, if the price of any one of the stocks were to drop to $0, the maximum downside risk posed to the portfolio by that particular stock would be 5%. Since your dollars are distributed evenly, each stock’s downside risk is also evenly distributed.
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