Portfolio Dilemma: is a 2% position too small?

An ii Community member asks:what is a reasonably sized position? If you hold 50 different shares, then on average each will be 2% of your portfolio. How small is too small?

(ii Community is a social trading network to connect with investors, talk about your investments and see how your portfolio compares to others) 

Questions like “how many holdings should I have?” or “what’s the perfect position size?” are integral to the investment process. But the immediate answer is ultimately along the unhelpful lines of “it depends…”. 

That’s because your goals, your preferences and your attitude will decide what’s best. But getting to grips with these can help you make a decision that suits you.

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If we call on some general rules of thumb, so-called core holdings that play a central role in your portfolio (like a broad tracker fund) could make up at least 10% of your assets, and sometimes much more. A riskier, satellite position might range between 2% and 5%.

Those who want to hold lots of individual equities, like the ii Community member who posed this question, could have lots of 2% positions, as they highlight.

But they could also have big positions in shares they view as stable and reliable, and then allocate smaller sums to riskier holdings. 

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Our latest DIY Investor Diary feature is a good example of this: the investor likes to use UK large caps as core holdings, including a roughly 7% allocation to BP (LSE:BP.). 

He then has smaller positions in riskier names, although he can sometimes run his winners here and end up with big positions, such as Rockhopper Exploration (LSE:RKH).

Your approach will have a big effect on your returns and the volatility of the portfolio. The key considerations are worth considering.

What should I weigh up?

For us, three Rs are useful when it comes to deciding on your position sizes.

Risk: how much risk are you taking? A 2% or even a 5% position cannot do too much damage if it performs poorly. A 10% position can be painful if it underperforms. And going for extremely big bets, as one customer has done with AST SpaceMobile Inc Ordinary Shares - Class A (NASDAQ:ASTS), creates a lot of stock-specific risk.

Reward: this is just the other side of the coin. A position of less than 2% will do very little to move the dial and is arguably too small. And if you have a lot of conviction in a position, having at least 10% of your portfolio could make it worth it.

Research: it’s hard to thoroughly research and monitor that many stocks, meaning you might want to focus on a small number of names, and back your conviction with bigger position sizes. This carries greater risk, but might be both more satisfying and effective.

The stress factor

Another factor that cannot be covered with an “R” relates to stress, and your ability to sleep at night. If having 20% in a stock causes you too much stress, it might make sense to dial down the concentration.

Generally speaking, you can pile more money into assets if they are more diversified. 

So, a 10% bet on a well-diversified, generalist equity fund should carry less risk than building a position of the same size in one equity. 

But a punchy, specialist and volatile fund might be treated more like a share in this respect.

Investors also need to ask whether they rebalance their holdings back to their original weightings to lessen the portfolio volatility, or whether they keep running their winners and allow their losers to shrink in the portfolio.

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The second approach is more instinctive and may work for investors who back riskier stocks. 

As our DIY Investor Diary series has noted, some investors have accepted the fact that some bets on risky small-cap shares could “go to zero”. 

However, they hope to offset this with the big returns they make when one of those stocks comes good, and they keep holding it rather than taking profits too early.

This more instinctive approach could lead to a portfolio of wildly differently sized positions. But it also might feel more natural to invest in this way. 

If you have a question you’d like to be considered in our Portfolio Dilemma series, we’d love to hear from you. Please contact: editorial@ii.co.uk