Position Sizing: There is No Magic Formula!

The question of position sizing and when to add to a position is one of the most common questions investors of all types have. Invest 50% initially into a position? 75%? Add when your position is down 20%? Add when your position is up 20%? How much of my portfolio should be in stock XYZ?

There is good and bad news to share with you. The goods news is that you don't have to memorize some magic formula to know these answers; the bad news is that there is no formula or prescription for knowing how much capital to invest in a position initially, when to add, and so on and so forth.

Said another way, it's up to you to determine your own level of comfort as it relates to these questions.

Matthew and I, for example, would give you different answers to these questions. For example, when asked by a member today about adding to initial positions, here was my response:

  • "I generally will add if I am down 20% or so on a position and I still have a high level of conviction; likewise, I will add if the company is executing even if the stock is much higher than where I purchased it initially."

Matthew responded to the same member with a response that I felt was spot on and eloquently stated:

  • "I personally buy an initial position in a stock after doing due diligence and speaking with management, and I average up over time as management executes. My initial position depends on my conviction and the margin of safety I see. I don't mind paying more when I add to my position because the investment will be further de-risked (hence my conviction is greater) as management has executed, and there's still usually a minimum of 2x of upside potential left."

So, while there are no right or wrong answers to these questions, here is the advice that Matthew and I can share with you that we have both found to be successful for us:

Regarding an initial position:

  • The amount of capital you commit to an initial position should be 100% correlated to your conviction in the company after you have done the necessary due diligence. If you feel incredibly confident in a company (thus high conviction), then you allocate more of your capital to that position. 
    • Matthew, for example, has 60% of his total portfolio in a single stock at the moment because his conviction level is extremely high in the company. 
    • I generally will not allow myself to have over 40% of my portfolio in a single stock, although there are times I have had 50% of my investing capital in a particular stock. 
  • Matthew points out, and I agree, that it's impossible to have very high conviction after the initial due diligence phase, it takes time to build conviction as you have to watch management's actions, and base your level conviction on that. So your longest owned positions should naturally be your largest.

When to add to a position:

  • The timing of when to add to a position again depends on your conviction. If a stock drops 10%, 20%, 30% from your entry price and your conviction and investing thesis is intact, then add.
  • If the stock rises 10%, 20%, 30% because management is executing and you see no reason for that to change, then add. 
  • One thing to keep in mind, obviously, is when you add to a position the position becomes a larger percentage of your overall portfolio.
    • I once allowed my portfolio to be concentrated up to around 80% in a single stock without realizing it! Fortunately for me this ended up very well, but if the stock moved in the wrong direction it would have really hurt!

Please leave any comments you have below as I know this is a simple, yet complicated subject that folks often struggle with.