Use this simple equation to determine how much you should invest in a single share
How much you invest in a single share could mean the difference between investment success and financial ruin. Should it be R1,000? R5,000? Even R8,000? The trick, says Warren Jeffery, head of research and trading at FSP Invest, is to use this simple equation…
If you’ve spent hours wondering how much money to invest in Sasol, Standard Bank or Coal of Africa, you’re not alone. This is one of the most common questions investors ask their brokers before buying shares.
And while your broker will always tell you that how much you invest depends entirely on you, this answer isn’t as helpful as it seems.
That’s where the Risk Ratio Method comes in…
The Risk Ratio Method: The best way to determine how many shares you should buy
To use the Risk Ratio Method, you need to know three numbers:
• Your investment portfolio’s value
• Your risk percentage – this is the percentage of your investment portfolio you’re willing to risk on any one investment. Most investment experts believe a risk percentage of 2% is ideal
• Stop loss percentage – this is the percentage you’ll allow a share’s price to fall before you sell the share and take the loss. A 25% stop loss is a good level for long-term investors
“Once you know these three numbers, you can calculate exactly how much money you should put into any one share,” explains Jeffery.
You do this by using the Risk Ratio Method equation:
Amount you’re willing to risk ÷ stop loss = Investment amount per share
Assuming your investment portfolio’s value is R100,000 and your risk percentage is 2% and your stop loss 25%, the equation looks like this:
R100,000 x 2% = R2,000 (this is the amount your willing to risk)
R2,000 ÷ 25% = R8,000.
So using the Risk Ratio Method equation, you should never invest more than R8,000 in a single share. If that sounds like too much money, simply lower your risk percentage or tighten your stop loss.
“So make sure you focus less on how much you invest and more on how much you risk,” cautions Jeffery. Use the Risk Ratio Method to “keep you safe from financial ruin and help answer the frustrating question of just how much you should invest.”