How Much Should I Invest in a Stock?
Admittedly, this blog will only appeal to the money nerds in the Vet Financial Summit tribe.
So if you base your decision to invest $X in a particular stock on a gut feeling, the alignment of the moon with the sun or a round number, feel free to skip this.
If you’d like a more scientific approach, then read on. It might sound super complicated, but we promise we’re going to take it step by step.
Step 1: In order to limit your downside (i.e. the amount you risk losing), you may want to consider using a stop loss. Many smart financial writers suggest a 25% trailing stop, and we tend to agree it’s a reasonable number for most investors.
Step 2: Then it’s a good idea to decide how much of your total portfolio you’re willing to lose on a given trade. Again, we agree with very wise financial writers who suggest 1% of your total portfolio. This is your “capital at risk”.
Step 3: The next step is to figure out how much to invest in a particular trade (usually a particular stock). This is called your position or position size.
OK, this is where it gets a tiny bit complicated. But honestly, if you’ve gone through vet school, you can handle the math!
Here is the magic formula: divide the number in step 2 by the number in step 1. Both a percentage.
Capital at risk / Trailing stop loss = Position size
In our example, 1% / 25% = 0.04 or 4%.
In plain English, this means that if you invest 4% of your portfolio in a particular stock, and you limit your downside with a 25% trailing stop, the most you could lose is 1% of your portfolio.
Are you with us so far?
Let’s take a real-life example… with a made-up stock: Acme Litter Boxes (ALB), which trades for $40.
How many shares should you buy?
Without a system, how do you decide? 5 shares? 17? 24? 50? 500?
With this system, it’s simple math.
Let’s say you have a $100,000 portfolio (remember, this is just an example, it doesn’t matter what the real number is!).
Step 1: Since your trailing stop is 25%, you will sell the shares if their price falls to $15 ($20 minus 25% or $5 equals $15).
Step 2: We agreed that you are willing to lose 1% of your portfolio, i.e. $1,000.
Step 3: Capital at risk / Trailing stop loss = Position size
We already calculated that your position size was 4%, and 4% of your total portfolio ($100,000) is $4,000.
Now remember, Acme Litter Boxes (ALB) trades for $40, so to know how many shares to buy, all you have to do is divide $4,000 by the share price ($40). You would then buy 100 shares.
Many financial gurus suggest keeping a log of all your trades, so you can learn as you progress in your financial journey.
You may want to consider doing that on a computer or in a simple notebook.
After you’ve done the math a few times, this will all become second nature.
Phil Zeltzman, DVM, DACVS
Meredith Jones, DVM
Co-Founders of Veterinary Financial Summit
Are you ready to conquer your financial future? Be sure to join us in September for the VFS Virtual Conference. At the conclusion of the event, not only will you have a better understanding of your financial future, you will also have created your financial plan, and become part of a Community of like-minded Veterinarians supporting one another throughout the year.