Position sizing can make or break your returns
By Vanguard
Investing strategy
The power of position sizing
I have a thought experiment. Assume you are given $25, and you can bet on a coin that has a 60% chance of coming up heads and a 40% chance of coming up tails.
You have 30 minutes to bet, enough for roughly 300 flips, and you can bet any way you want, with a maximum potential payout of $250.
How much would you bet?
There is a mathematical solution to such a problem.1 But what is interesting is that this was a real experiment, and the results were surprising to say the least.
The researchers, investment professionals Victor Haghani and Richard Dewey, found that their subjects — 61 financially-sophisticated students and young investment professionals — performed poorly, even though they were presented with a wonderful betting opportunity.
Most shockingly, 28% of the subjects went bust.
“We did not appreciate just how ill-equipped so many people are to appreciate or take advantage of a simple advantageous opportunity in the presence of uncertainty,” the researchers wrote.
“The straightforward notion of taking a constant and moderate amount of risk and letting the odds work in one’s favour just doesn’t seem obvious to most people.”
The importance of position sizing
Of course, there are significant differences in betting on a coin flip to managing an investment portfolio.
But the experiment is a reminder that betting too much or too little can lead to poor results, even when the investment opportunity itself is attractive.
Instead of betting a fixed fraction of their $25 on each flip, Haghani and Dewey found their subjects employed a range of non-optimal bet strategies, such as doubling down after losses.
In a stock market context, this can be disastrous.
For example, if you invested 10% of your portfolio in a single stock that fell 50%, then committed another 10% of your original portfolio to the same stock, and then it fell another 50%, you’d have lost 12.5% of your portfolio — more than your initial 10% stake.
Similarly, if you have a good investment, but it’s sized too small, the impact on your returns could be insignificant.
When it comes to picking winning stocks, it’s important to remember that the odds are against you. Research by S&P Global found that 84.4% of Australian large-cap equity funds underperformed the S&P/ASX 200 index over the 10 years to June 30, 2025.
A simple way to build a portfolio
Position sizing isn’t just about individual bets. It’s about how you allocate across your entire portfolio.
One way to manage this is through diversified ETFs, which spread risk across thousands of securities.
Vanguard offers a range of ready-made diversified ETFs, which provide investors with access to multiple asset classes and sectors in single funds tradeable on the ASX.
These products combine thousands of Australian and international shares, bonds and other assets in different proportions to suit a range of investment objectives, risk profiles and investment time frames.
- The Vanguard Diversified Conservative Index ETF (VDCO) has a 30% allocation to growth assets (such as shares) and 70% to defensive assets (such as fixed income).
- The Vanguard Diversified Balanced Index ETF (VDBA) has a 50% allocation to growth assets and 50% to defensive assets.
- The Vanguard Diversified Income ETF (VDIF) targets a 60% allocation to growth assets and a 40% allocation to defensive assets.
- The Vanguard Diversified Growth Index ETF (VDGR) has a 70% allocation to growth assets and 30% to defensive assets.
- The Vanguard Diversified High Growth Index ETF (VDHG) has a 90% allocation to growth assets and 10% to defensive assets.
- The Vanguard Diversified All Growth Index ETF (VDAL) has a 100% allocation to growth assets and 0% to defensive assets.
When comparing investment options, consider whether the asset allocation aligns with your risk appetite and long-term goals, and don’t be distracted by short-term market movements or performance.
Remember, all investments carry risk, and past performance is not a reliable indicator of future returns, so do your own research.
1 The Kelly Criterion is a formula designed to maximise long-term wealth by calculating the optimal fraction of your bankroll to allocate to a bet, assuming the probabilities and payoffs are known. In this favorable coin-flip scenario, the formula suggests wagering around 20% of your account balance each time. However, this approach does not apply to stock market investing, where the odds and expected returns are uncertain and cannot be precisely calculated in advance.