How much of your money should be invested in one ASX stock?

Whether you bought your first ASX stock or ETF yesterday or have held it for years, portfolio management is a principle that needs to be understood. Owning shares is a great way to invest your capital for many reasons but there are also a lot of factors that need to be considered.

In this article, we will exclude the concept of asset allocation and assume the only class of asset you are investing in is equities (shares/ETFs). There are several ways you can look at portfolio management, but at the core it is how to diversify your investments to maximise return while minimising risk.

Why should I be diversifying my portfolio?

Each company that you own will be exposed to varying business/operational/sector risks. For example, Commonwealth Bank of Australia (ASX: CBA) has different operational concerns to Rio Tinto Limited (ASX: RIO) – one is a bank and the other is a miner.

If you place all your investment capital into one company, then your entire portfolio's performance is underpinned by that company's success, which is dangerous.

If you were to own shares in 5 companies that varied in their core business activity and one of 5 started performing badly, the other stocks will help lessen the impact upon your portfolio. Spreading your capital into uncorrelated shares is a good way to do this. For example, a diverse portfolio of 5 ASX shares could look like:

1. Commonwealth Bank of Australia (ASX: CBA)
2. Rio Tinto Limited (ASX: RIO)
3. Woolworths Group Limited (ASX: WOW)
4. Telstra Corporation Limited (ASX: TLS)
5. Goodman Group (ASX: GMG)

All of these companies operate in very different sectors. For example, if Commonwealth Bank underperforms due to a sector related issue, such as the banking royal commission, the other sectors are probably going to be less affected by this issue.

How much money should I invest in each stock?

A great rule of thumb is to allocate no more than 20% per stock in your portfolio, which means you should own at least 5 stocks.

Working out how much money should be allocated to each stock is called 'weighting a portfolio'. Below is an example of a weighted portfolio:

This example portfolio shows that the owner understands diversification. Note that the portfolio has placed more money into Commonwealth Bank than Telstra. This is a reflection of the owner's views on those 2 companies – they have placed more weight into Commonwealth Bank because they believe that it is a better investment opportunity then Telstra.

How can I diversify with limited money?

Quick maths tells us that if we want to own 5 stocks on the ASX with a minimum of $500 parcel per stock, we are up for a total of $2,500. For some this is too much to get started.

In that case, ETFs can provide the same (if not more) diversification. Take the Vanguard Australian Shares Index ETF (ASX: VAS). This ETF exposes you to the top 300 companies on the ASX, and the minimum investment is still $500.

ETFs can be used within a portfolio like the one above to add a bit of extra market diversification – like so:

Note: if you only hold ETFs such as VAS this may be adequate diversification for your situation as the ETF is comprised of a diverse portfolio of stocks.

But be warned! Over-diversification can also negatively impact your portfolio returns. Owning a few ETFs is sufficient, owning 20 ETF's with overlapping underlying stocks means you are costing yourself management fees for no further diversification.

Foolish takeaway

If you own ASX shares and aren't diversified, please use the examples above to inspire you to re-weight your portfolio. This can be achieved through selling current shares and buying others or by simply adding an ETF to your holdings. In the long term, diversification is worth it.