Contents

The Position Sizing Conundrum

As a follow up to my How I Identify New Companies to Research post, in this post I address the position sizing conundrum investors face when trying to determine how to properly size a position within an investment portfolio.

Dollar versus Percentage Perspective

Determining how much weight each particular stock receives in a portfolio is very subjective. The weighting of an investment, however, has a significant impact on a portfolio’s overall return. This is because each stock in the portfolio contributes to the overall return by way of its return AND to the extent of its size in the overall portfolio.

Some investors tend to focus on an individual stock’s return. If our best performing stock, however, is negligible in relation to the overall portfolio then its impact on the overall portfolio return will also be quite limited. Naturally, the reverse applies if the investment is a ‘loser’.

This simple example explains why I prefer to look at my holdings from a dollar versus a percentage perspective.

  • Investor A invests $10,000 in Company X at the beginning of the year and it appreciates in value by 20%. At the end of the year, this holding is worth $12,000.
  • Investor B, on the other hand, invests $500,000 in Company Y at the beginning of the year but it appreciates in value by ‘only’ 15%. At the end of the year, this holding is worth $575,000.

If we evaluate performance from a percentage perspective, Investor A comes out ahead (20% versus 15% for Investor B). I would, however, much rather be investor B given that my investment has appreciated in value by $75,000 versus $2,000 for Investor A.

Looking at various postings on social media, it appears some investors fixate on percentage changes.

How Many Holdings Are Reasonable?

We each have our respective goal, objectives, and risk tolerance. It is, therefore, no surprise there are different opinions on how many holdings are reasonable. Some investors feel comfortable having exposure to 10 or fewer companies. Others prefer greater diversification. Some go to the extent of 'throwing mud on the wall'. The introduction of the ability to purchase fractional shares has not helped the situation!

When I completed my 2024 Year End FFJ Portfolio Review, I had exposure to 7 Canadian and 50 US companies and 85% of our total exposure was held in 30 companies. I have subsequently reduced this to 7 Canadian companies and 48 US companies; I exited two smaller holdings as part of our Registered Retirement Savings Plan meltdown strategy.

Some investors have a specific approach when it comes to determining position sizing with some setting out clear rules in advance. This can lead to frequent rebalancing so as stick as closely as possible to intended allocations.

Other investors, such as me, have no clear rules. While some investors may cull exposure in a company when its weighting becomes significant, I am reluctant to sell. I have no objection to increasing my exposure to my top holdings. If necessary, I can also rebalance my holdings by adding to different existing holdings.

What About Investing New Funds?

Position sizing becomes even more complex when we have new funds to invest. Do we add to existing positions or do we initiate new positions?

Suppose there is a $10,000,000 portfolio for which $1,000,000 was invested in 10 companies.

The value of each investment will change over time and not every investment will perform the same. If one investment increases to $6,000,000 while the value of every other holding increases to within the $1,500,000 - $2,000,000 range, how should an investor deploy 'new' money?

Having a ‘prospect list’ adds to the positioning size conundrum. What if ‘all the stars’ align thereby making some of these 'prospects' attractive investment opportunities?

As an example, I initiated a new Cintas (CTAS) position on December 19 and increased this exposure with the purchase of another 200 shares on December 31. If I had a rigorous investment sizing policy, I may not have been able to make these purchases.

The World Is Dynamic and Evolving

Adding to the complexity of position sizing is that portfolios are constructed and managed in a dynamically evolving world where:

  • stock prices and portfolio weights constantly change; and
  • investors’ perceptions of the expected return and risk of individual stocks also change.

If our position sizing policy is too rigorous, we might find ourselves in a position where we are buying/selling far too frequently.

How I Determine Individual Position Sizes

Since I do not follow a rigorous investment sizing policy, I have the flexibility of being able to seek opportunities without concerning myself with weightings. I have a sufficient number of holdings (even a few too many) where my current exposure is only 2% - 4% of our overall holdings. Investing new money to existing positions, therefore, does not give rise for concern.

In my 2024 Year End FFJ Portfolio Review, I disclose:

  • The top 30 holdings comprise ~85% of our total holdings;
  • The top 10 holdings comprise ~46%;
  • The top 11 - 20 holdings comprise ~24%;
  • The top 21 - 30 holdings comprise ~15%; and
  • The top holding (VISA) comprises ~10.6%.

I recognize it is ironic that I express the value of our holdings in percentage terms considering my comments in the Dollar Versus Percentage Perspective section found earlier in this post.

When I complete my semi-annual portfolio reviews, however, I reflect my exposure in percentage terms because my analysis includes holdings in retirement accounts for which I do not disclose details for confidentiality reasons AND accounts within the FFJ Portfolio. Visa, for example, is our largest holding. It is a relatively small holding within a 'Core' account in the FFJ Portfolio. One of our retirement accounts, however, has a 7 figure exposure to Visa.

Industry Exposure

In determining how to properly size a position, I also consider my sector and industry exposure.

I have exposure to the following companies in, for example, the Healthcare sector:

  • Agilent
  • Becton Dickinson – 25th largest holding
  • Danaher – 19th largest holding
  • Fortive
  • Intuitive Surgical – 7th largest holding
  • Johnson and Johnson – 21st largest holding
  • Merck
  • Thermo Fisher – 22nd largest holding
  • Veeva Systems – 28th largest holding
  • West Pharmaceuticals – 18th largest holding

It may appear that I might have too much exposure to the Healthcare sector. Several of these companies, however, are not direct competitors. Intuitive Surgical, for example, does not remotely compete against Veeva Systems or West Pharmaceuticals.

I also purposely invest in companies that are direct competitors (eg. Automatic Data Processing, Paychex, and Paycom). Once I understand an industry, I find it is easier to compare/contrast industry participants.

Risk Assessment

I include a risk analysis when position sizing.

Risk, for me, has nothing to do with share price volatility but rather:

  • the type of company and its business operations;
  • the level of corporate governance;
  • indebtedness;
  • return on capital and capital allocation priorities; and
  • growth potential.

When Would I Actively Reposition Through A Sale?

Although I rarely sell, there are situations where I will rebalance through a sale as opposed to increasing my exposure in other holdings.

In May 2024, I exited several holdings with disclosure provided in posts that are accessible through The FFJ Archives.

Final Thoughts

I am inclined to invest in companies that may have a lower expected return but where the potential return estimate is both more reliable and more accurate versus investing in a company that is speculative in character and whose earnings outlook is less reliable. Given this, I have no issue with increasing a position's size even though I may already have significant exposure; I increased my Visa (V) and Mastercard (MA) exposure in July 2024 even though they were already two of my largest holdings.

Whether you agree with my opinion about position sizing or not, it is imperative that you keep in mind Warren Buffett’s following two rules of investing.

Rule #1 – Don’t lose money

Rule #2 – Don’t forget rule #1

I wish you much success on your journey to financial freedom!

Note: Please send any feedback, corrections, or questions to [email protected].

Disclaimer: I do not know your circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your research and due diligence. Consult your financial advisor about your specific situation.