Purchase minimum positions for affordable costs
Investors face minimum positions for affordable costs so costs drive investor position sizes. The second sizing factor to consider is getting the transaction costs right. Right means a low-cost per share. This effectively puts a financial barrier or threshold for owning an individual share position. It is a cost driven factor.
White Top View series: Portfolio Counts and Sizes, Part 4 of 6
You want to make sure your cost of buying shares has an acceptably low-cost per share. That means there is a practical smallest lot price. That is how costs drive the smallest practical position size.
For example, a $10 commission to buy 100 shares, the net cost to you is the share price + $0.10 per share. Simply divide the $10 commission cost by the number of shares purchased.
If your commission cost is higher, say $400, the cost per share becomes share price + $4. The same calculation applies. Divide commission cost by the number of shares purchased.
To buy 100 shares at a price of $2.50/share, the low commission cost above gives you a net cost of $2.60 and the high commission nets the cost as $6.50. If the share price is $28.00 the low commission cost nets $28.10 and the high, $32.00.
That means the $2.50 share has to increase by as little as $0.10 or far less than 1% before beginning to make money for the low commission account. For the high commission account the change has to be a huge 260% to just break even.
To buy the $28.00 share, the low commission account quickly begins making money and the high cost account needs the price to increase over 14% before going positive!
That first scenario immediately puts you in a negative situation. Beginning in a deep cost hole leaves little chance of seeing a reasonable rate of return.
Buying more shares changes the relative costs
You can radically change the unit costs by buying more shares. For example, move the number of shares purchased up to a 10,000 share lot. Costs per share quickly get reasonable. The $10 commission only adds a tiny fraction of a penny to the share cost per share. The $400 commission adds $0.04. Both affordable amounts with little portfolio performance impact.
Dollar amounts to consider
Rounding lot numbers up helps performance. That can mean buying a smallest position of $2,000 to spread the costs over enough shares to cover commissions of $10. When commissions are higher it could mean the smallest order you should consider is much higher. A $10,000 order can proportionally cover commission costs of $400.
Obviously the share price itself remains a major factor in determining the answer for each position size.
We buy in lots and multiples of 100 shares as well as dollar amount of $2,000 to $10,000, depending on transaction costs have to be considered when determining the number of shares held in each position. Because costs drive investor position sizes, each specific position may hold a substantially different number of shares.
Next in Part 5 of the White Top View series: Portfolio Counts and Sizes, we will discuss the range in portfolio value to consider in each position as prices change over time.
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Links to all parts of the White Top View series, Portfolio Counts and Sizes: