Share Sleuth's notepad: How much to invest in a company
Deciding how much to invest in a company can be as taxing as deciding which company to invest in. These are the Share Sleuth portfolio rules.
Originally the Share Sleuth portfolio had a different name, the Thrifty 30. We changed it for two reasons. It was easy to confuse with the Nifty Thrifty, the mechanical portfolio I run for Money Observer, and it tied me to including thirty shares. As my confidence in some of the constituents grew, and my confidence as a stockpicker did too, I preferred to back my convictions and include fewer shares. That made it more difficult to decide how much to allocate to each trade.
When I started it was easy. The portfolio had a notional £30,000 so the size of each trade was simply that figure divided by the thirty stocks it would ultimately include, which is £1,000. Since then the portfolio has grown, it’s worth over £41,000, and there is no fixed denominator, or target number of shares, to divide into it.
I feel very confident about some of the shares in the portfolio, companies like Dewhurst (DWHT) and Castings (CGS) that head the Watchlist, but I still wouldn’t put the entire portfolio into a handful of those companies. I could be wrong, overconfident, there are certainly many more things I don’t know about my favourite shares than I do, and some of the things I don’t know might be significant.
The first rule is designed to maintain diversification in the portfolio without forcing me to sell successful investments if I don’t want to. It’s:
#1 Do not buy more of a share if it will subsequently account for more than 10% of the portfolio by value.
This rule stopped me adding more Dewhurst shares recently.
Including fewer shares in the portfolio means there’s more to invest in each one. If I have a new idea, according to the 10% rule I could invest £4,000 in it. If the portfolio grows to £100,000 that could be an initial investment of £10,000. It’s more than I’m comfortable risking on one decision considering emotions vary, and I might be particularly gung-ho one day.
I don’t trust myself to invest 10% of the portfolio all at once, preferring to build up positions in companies, and sometimes scale them down as I become more familiar with them. So I’ve settled on a second arbitrary rule:
#2 Do not trade more than 3.3% of the portfolio in a single trade
That puts the current limit at £1,350.
Rules sound constricting, but if they simplify they’re liberating. I’ve liberated myself from worrying how much to invest each time I trade. It’s made deciding whether to add more shares or eject them a binary decision. Either a company meets my requirements, or it doesn’t. If it meets them, I know how much to risk. I don’t consider shades of confidence and the possibility of a big bet. Deciding to trade is exhausting enough as it is, and the rules have removed some of the emotion involved.
Short-term traders, aka the dark side, use money management rules like these and I’m not surprised. If you are trading every day, making quick decisions is your competitive advantage and protecting yourself from blow-ups is a matter of survival.
About the author
Richard is companies editor of Interactive Investor and a columnist at Money Observer magazine. A keen private investor through his Self Invested Personal Pension, he manages two virtual portfolios. The Share Sleuth portfolio is a hand-picked collection of mostly small-cap value shares, while the Nifty Thrifty is a mechanical portfolio designed to pick large, successful companies at cheap prices.
Richard Beddard's tweets
- Any mechanical investor shld read: MT @Stockopedia: And this is just classic - Mining Fool's Gold - http://t.co/XnYbNXYzga — 44 weeks 4 days ago
- @MrContrarian :-) — 45 weeks 16 hours ago
- Mervyn King on Desert Island Discs now :-) — 45 weeks 20 hours ago
- MT @Stockopedia Another newish UK investing blog: http://t.co/KacB5XFF1P < Uses residual income model, not seen that b4 regularly on a blog — 45 weeks 4 days ago
- @Thevalueteam I agree, but its hard to go to cash... — 46 weeks 1 day ago
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