You’ve done the research and you found a company with unbeatable fundamentals, a cheap valuation, and accelerating momentum. Everything about the stock says it’s time to go all in.
But going all in isn’t an investment strategy. It’s a mistake that can cost you your entire portfolio if a single stock stumbles.
What you need is a plan that maximizes upside when you’re right without wiping you out when you’re wrong. In this guide, I’ll offer simple, battle-tested rules for managing your investing risk and sizing positions so you can feel confident in your portfolio.
The 4 Pillars of Investing Risk Management
The biggest risk most long-term investors face isn’t day-to-day volatility in the overall market. It’s the risk of buying a fundamentally flawed company, riding it down 80%, and never making your money back.
So, risk management is all about creating guardrails that stop that from happening. Here are the strategies I use and that you should, too.
Write down your thesis
You should always know exactly why you own a company. Before I buy a single share, I write down my investment thesis in three bullet points. If I can’t explain how the company makes money, what its competitive advantage is, and what catalyst will drive future growth, I don’t buy it.
After I buy, I return to this thesis over and over again. When the price drops, I check my thesis. If it’s still intact, I keep holding—or even pick up extra shares at a discount.
But the moment that thesis stops being true, it’s time to exit. There’s no bargaining or waiting for it to bounce back. I take the 20% loss and avoid turning it into an 80% loss.
Buy quality companies, not cheap ones
It’s extremely tempting to buy a company that’s 50% off its all-time high or that just dropped 15% on earnings. It looks like a deal.
But stocks usually go down for a reason, and just because you’re entering below the high doesn’t mean your position is any less risky.
Follow the same research process you would for a company trading at all-time highs and demand the same level of quality.
Have an exit plan
Before you enter any position, have a plan for when you’ll exit—even if your thesis remains intact.
That could be a maximum drawdown, like 10% or 20%. It could also be a fundamental change unrelated to your thesis, like a change in analyst ratings or a shift in company leadership.
Defining your plan from the beginning allows you to make decisions before you commit money to a stock, not when you’re losing money and emotions are running high.
Stay diversified
Building a portfolio of 10-20 individual stocks sounds like diversification. But if all those stocks are in the same sector, you’re not actually any safer from a downturn. You just made the same bet 10 different ways—and you’re set up to lose all 10 if something goes wrong.
True diversification means spreading your risk across different business models, sectors, and economic drivers. My rule: cap any single sector at 25% of my portfolio.
It’s simple to follow and forces me to think about how different sectors might respond to different market catalysts. For best results, match holdings in high-growth industries like tech with non-correlated stocks in defensive industries like healthcare or industrials.
Practical Rules for Position Sizing
Even stock picking geniuses like Warren Buffett are wrong a lot of the time. What makes them great is knowing how to size their bets so that the profits from their best ideas far exceed the losses from their worst ones.
Position sizing is how you amplify risk or control it—and it’s where many investors break all their own rules. Thankfully, position sizing is also easy to master. Here are a few practical rules you can follow.
Use tiered position sizing
My favorite way to size positions is by using conviction as a filter.
My best ideas get 5% of my portfolio—not more. I size medium-conviction ideas at 2-3% of my portfolio, and more speculative or higher volatility ideas at just 1%.
This approach ensures my position sizing doesn’t just reflect enthusiasm. It also accounts for the risk of being wrong.
Crucially, it also limits how much I can lose in a worst-case scenario. Say I have 20 positions at 5% each, and 5 of them drop 20%. My overall portfolio only loses 5%, which is bad but hardly catastrophic.
Don’t forget to check what’s in your ETFs when using this approach. Overlap between individual stocks and ETFs can push positions over that maximum 5% allocation without you realizing it.
Scale into positions
Even my best ideas rarely start out with a full 5% allocation. Instead, I size them at 2-3% of my portfolio, then add as momentum builds and my thesis confirms. Scaling in like this links sizing directly to confidence.
It also creates a profit buffer in my position. If I’m up 10% on my first batch of shares in a company, I can pick up another batch and know that I’ll still be sitting on a net gain even if the price drops.
Apply the sleep test
Every investor’s risk tolerance is different and there’s a lot of psychology at play when you see red in your brokerage account. So, there’s no one-size-fits-all position size I can recommend for every situation.
Instead, I like to apply what I call the “sleep test” as a gut check on whether a position is sized appropriately. If I’m losing sleep over a stock or checking the price daily, that’s a sign I’ve taken on more risk than I can handle.
The solution is to size down or exit the position entirely. You can also use this test to better understand your own risk tolerance and adjust your position sizes going forward.
Rebalance regularly
While I like to keep positions to 5% of my portfolio, the reality is that winners often grow beyond that. It’s important to find a balance between letting your best ideas run and making sure they don’t take over your portfolio.
For me, that balance is right around 10% of my portfolio. Once a stock grows beyond that threshold, I’ll sell enough stock to get back towards my target 5% allocation and use the cash to invest in my next great idea.
Keep some cash on hand
You don’t have to be fully invested all the time. In fact, I don’t recommend it.
Keeping 5-10% of your portfolio in cash ensures you’re ready for the next market crash. That cash doesn’t go down in value while stocks fall, and it’s less tempting to panic sell when you see at least one portion of your portfolio remain afloat. Even better, your cash position also serves as dry powder so you can buy quality companies on sale.
Cash isn’t just parked money. It’s an active position sizing and risk management tool.
Master Risk Management for Long-term Success
At the end of the day, successful long-term investing isn’t about finding a crystal ball. It’s about building a repeatable system that manages risk and maintains discipline in your position sizing.
If you can protect your downside with clear rules and keep mistakes small through proper sizing, all it takes is a few great ideas to compound your returns.