Risk Management for Investors

Risk management is not about avoiding risk — it is about taking the right risks in the right amounts. Every pound you invest should be a deliberate decision about how much downside you can tolerate.

Position Sizing: The 5% Rule

Never put more than 5% of your portfolio into a single stock. This means that even if one investment goes to zero — which happens — you lose a maximum of 5% of your total capital. With 20 equal positions, one failure reduces your portfolio by 5% while the other 19 have the opportunity to more than compensate.

Correlation

Diversification only works if your holdings are not all correlated. Ten UK bank stocks is not diversification. Aim for variety across sectors, geographies (UK and US), company sizes, and investment theses.

The Kelly Criterion

For advanced investors, the Kelly criterion provides a mathematical framework for optimal bet sizing: f = (bp - q) / b where b is the odds received on the bet, p is the probability of winning, and q is the probability of losing. In practice, most investors use half-Kelly or quarter-Kelly to reduce volatility.