Steve Sjuggerud’s note: Today’s DailyWealth is the fifth in our holiday series of issues written to help make you a better investor. For how much to invest in any single investment, read on...
How Much To Invest In Any Single Investment
By Dr. Steve Sjuggerud
December 30, 2006
It doesn’t matter what you’re trading, or investing in. You can’t put too many eggs in any one basket.
As a rule, I never put more than 5% of my total portfolio in any single investment idea. And I’m more comfortable never putting more than 4% in any single investment.
You see, another misconception about our trailing stop loss strategy is failing to understand how stop losses must be used in conjunction with proper position sizing.
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The whole purpose of using a trailing stop loss is to prevent what I call a catastrophic loss. A catastrophic loss occurs when any single position in your investment portfolio experiences losses large enough to wipe out your other gains and/or jeopardizes your access to capital.
Using a 25% trailing stop loss will not prevent you from suffering a catastrophic loss if you invest half of your portfolio in a single position.
And speaking of position sizes, one of the biggest differences between professional investors and amateur investors is the size of their positions relative to their total portfolio. Professionals consider a 2%-3% position enormous. Having 5% of your money in any one position is considered “gun slinging” by most professionals.
Meanwhile, at conferences, when I tell investors they should never allocate more than 4% of their portfolio to any stock initially, people look at me as if I’m nuts.
In fact, I would bet that 99 out of 100 individual investors wouldn’t even know how much money they can afford to invest in a given stock, limiting the position to only 4% of their portfolio. Instead, almost all individual investors measure their position sizes in terms of shares, typically round numbers, i.e. “I own 50 shares.”
I recommend that when you decide to buy a stock, any stock, you consider 4% of your portfolio to be your maximum initial allocation. I also recommend you always use a 25% trailing stop loss if you do take a position that large. Why?
Because the combination of a 4% allocation and a 25% stop loss means that, at most, you’ll lose 1% of your total portfolio. Almost any investor can afford to suffer setbacks of this magnitude and still beat the market.
Think like a pro – think about your positions as a percent of your portfolio, not as a number of shares. Know the stop loss points of all your positions, at all times.
This doesn’t mean you have to check the stock tables every day. Once a week is plenty.
