You will be able to compare three sizing methods and choose one for your stock positions.
Marcus added up his four single stocks and found S$51,000 spread in a way he'd never chosen. His bank holding was S$16,000 because a colleague had recommended it the year he got a bonus. The chip designer was S$15,000 because it had risen. Larkspur was S$8,000 because that was what he had in cash the week he heard about it. The S-REIT was S$12,000 for reasons he couldn't remember. Each position's size was an accident of timing, and the risk dashboard from lesson 2.8, Build a risk dashboard for your portfolio and two benchmarks, had already shown him the result: more risk than his benchmark, without more return.
Modules 8 and 9 tell you what a company might be worth. They don't tell you how much of your money it should get. This module does, starting with three ways to size a position. Figures are made up unless they're Marcus's portfolio figures from earlier modules.
Take a made-up portfolio of ten stocks worth S$50,000. Their yearly volatilities, from lowest to highest, are 15%, 18%, 20%, 22%, 25%, 28%, 30%, 35%, 40% and 45%.
Equal weighting gives every position the same amount: S$5,000 each. It's the simplest method there is, and its strength is what it stops you doing. You can't put a fifth of your money into your favourite idea, because the method doesn't allow favourites.
Conviction weighting gives more to the ideas you rate most highly. Say you rank the ten and weight them 18%, 15%, 12%, 10%, 10%, 8%, 8%, 7%, 6% and 6%. Your top idea gets S$9,000 and your bottom two S$3,000 each. The case for it is obvious: why give your tenth-best idea as much as your best? The case against is that your confidence and your accuracy aren't the same thing. Behavioural Finance: why you make the money mistakes you make shows in lesson 6.2, Overconfidence and the cost of trading often, how far most investors overrate their own judgement. Conviction weighting magnifies that error, because it puts the most money where you're most confident, which is also where you're most likely to be overconfident.
Volatility weighting gives less money to more volatile stocks, so that each position adds a similar amount of risk. Weight each stock by one divided by its volatility, then scale the weights to add up to S$50,000. The 15% stock gets about S$8,280, the 45% stock about S$2,760, and the rest fall in between. Multiply each amount by its volatility and every position comes to about S$1,240: each would move the portfolio by roughly the same amount in a typical year. The weakness is that volatility comes from past prices, and lesson 2.1, Volatility: what standard deviation captures and what it misses, showed how a calm window can understate it.
Compare the extremes. Equal weighting puts S$5,000 in every stock. Conviction weighting ranges from S$9,000 to S$3,000, a ratio of three to one, set by your opinions. Volatility weighting ranges from about S$8,280 to S$2,760, also three to one, but set by measured price swings.
So the methods protect against different mistakes. Equal weighting protects you from yourself. Volatility weighting protects you from a few wild stocks dominating the portfolio's swings. Conviction weighting protects you from nothing, and rewards you only if your rankings are good, which you can check over time by comparing your top-ranked ideas' returns with your bottom-ranked ones. Most investors who try that check find little difference.
You can combine them. A common approach is equal weighting with a cap linked to volatility, so the most volatile stocks get a smaller share, and conviction only decides whether a stock is in the portfolio at all.
Marcus chose equal weighting with a volatility cap for his single stocks. Every stock gets the same target, set as a share of the whole portfolio, and any stock whose volatility is above 30% a year gets a smaller one. Using his own made-up estimates, his bank and S-REIT have volatilities of about 20% and 18%, so they'd get the full target. Larkspur, thinly traded and cyclical, sits at about 35%, and the chip designer at about 45%, so both would get the smaller target.
That choice changes his positions in obvious ways. The chip designer, his second largest stock, would shrink, and Larkspur would stay roughly where it is. Lesson 8.6, Sensitivity tables and scenarios instead of one target price, found that a bad cycle could take Larkspur to about S$1.05 a share, a loss of about a third, and a smaller target caps what that does to the portfolio. Lesson 11.3, Position and sector limits, and concentration risk, puts numbers on the targets.
Whichever method you choose, write it down now, before you find your next idea. A sizing rule written in the excitement of a new discovery tends to be written to fit that discovery. One written in advance is a commitment, and it makes the next decision smaller: you only have to decide whether a stock goes in, not how much it gets.
Marcus wrote one line in his workbook: "Single stocks are equal weighted at a set share of the portfolio, with a smaller cap for any stock above 30% volatility. Conviction decides what I own, never how much."
For the activity, you'll size the made-up ten-stock portfolio of S$50,000 by all three methods, using the volatilities above, and compare the largest and smallest positions under each.
Size a made-up ten-stock portfolio of S$50,000 by all three methods and compare the largest and smallest positions.
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