If you start investing and building your first investment portfolio, you may not know how much of a single stock you should own, and it may be a difficult question to answer. Should you invest your whole portfolio into a single stock, or should you diversify, what percentage of your portfolio should be exposed to a single stock?
This article will answer all of these questions and provide you with tips and recommendations to help you determine how much of a single stock you should own in your portfolio.
Factors you need to consider
Determining how much of a single stock you should own in your portfolio depends on a few factors you must carefully consider before making a decision.
One of the first factors you need to consider is your risk tolerance. Some investors are able to deal with risk and volatility well, while others can’t. If you can’t deal with the volatility and can’t tolerate risk, it is best to avoid having a large percentage of your portfolio allocated to a single stock. Instead, you should try to diversify, to reduce the risk and the volatility your portfolio may experience.
Another factor that will influence how much you should invest in one stock is your investment goals. Someone with higher investment goals will need to take additionally more risk to be able to achieve them, while an investor with smaller goals will not have to take as much risk.
For example, an investor that wants to achieve higher investment goals might choose to put a large percentage of their portfolio into a single stock, while an investor with simpler goals can diversify across multiple stocks.
Concentration vs. diversification
Understanding the differences between a concentrated and a diversified portfolio is a crucial aspect of building a portfolio. Some investors want higher returns and are willing to take on more risk and deal with a higher level of volatility to achieve their goals.
Others are looking for ways to preserve capital and prefer a diversified portfolio that can withstand the volatility and risks associated with investing.
Size of the portfolio
If you have an extensive portfolio, you want to avoid having a large percentage of it exposed to a single company. Instead, it will be safer to diversify your holdings. A larger portfolio makes it easier to achieve your desired returns, because a smaller percentage return will still generate a lot more money.
If you have more money in your portfolio, a simple 10% return will be more than enough to make a significant amount yearly. While if you have a smaller portfolio, you may need to take additional risks to achieve the same nominal returns.
Finally, your investment strategy will also influence how much of an individual stock you should have in your portfolio. For example, if you follow a value investing approach and your risk tolerance is higher, you might allocate 30% to 50% of your whole portfolio to a single stock.
If you want to take a more passive investing approach, you might diversify your portfolio across several stocks, and keep their weight on the portfolio relatively small, to reduce the risk and volatility.
What percentage of your portfolio should be in one stock?
After carefully considering each one of the factors we mentioned, you need to define how much you should allocate to a single stock. On average, for a relatively small portfolio, you should stick to a maximum of 10% for a single stock. This ensures that if anything goes wrong, you will only lose 10% of your portfolio, which is almost the average annual return for the S&P 500.
Consider that even a 10% allocation to a single stock in a portfolio requires a lot of risk tolerance because due to weight of it can make your portfolio fluctuate a lot in price.
Some investors with a higher risk appetite and tolerance can even consider allocating up to 50% of their portfolio to a single stock. However, you should be aware that this can be risky, and your portfolio will undoubtedly experience a lot more volatility that you might not be prepared to handle.
How much should you invest in a single stock?
Determining how much of your portfolio you should invest in a single stock will depend on the mentioned factors and the stock itself. How confident are you that the stock will go up? What is your expected holding period for this investment thesis to work out?
If you are very confident that a specific stock will beat the market over the long term, and you are willing to hold it through the ups and downs, then you can allocate a more significant percentage of your portfolio to it.
Make sure you can handle the risks and volatility associated with the stock you are picking and that the investment thesis is solid. You want to avoid investing a large percentage of your portfolio into a stock that you are unsure of how it will perform in the future. Ideally, your biggest holding should not be the one with the highest possible upside but the one with the lowest downside.
How much single stock is too much in a portfolio?
If you are taking more risk than what you can handle, then you should reduce the weight of a certain stock in your portfolio. Remember that if your portfolio is not letting you sleep at night, then you might readjust it to your sleeping threshold.
"Investors should always keep in mind that the most important metric is not the returns achieved but the returns weighed against the risks incurred. Ultimately, nothing should be more important to investors than the ability to sleep soundly at night." - Seth Klarman
This is why considering how much of a single stock you should own in your portfolio should be a decision each investor needs to make on his own. Since the investment goals, risk tolerance, and strategies are different for each investor, you should carefully choose how much you can allocate to one single stock.
Maximum percentage of the portfolio in one stock
Even for investors with a long-term mindset, and a high-risk tolerance, you should never allocate more than 50% of your whole portfolio to a single stock idea. The reason is that if your investment does not play out as you expect, you can see your portfolio value decline by as much as 50%. This kind of loss can have a devastating effect on your ability to continue investing and compound your money in the future.
Therefore you should consider the worst-case scenario, and if you own 50% of your portfolio in a single stock, your portfolio could eventually lose half of its value if the stock goes to 0. Additionally, if you are using margin, you need to be aware that the risks you are facing, and you should adjust the percentage of the stock you own to avoid going into debt or facing a margin call.