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Size.
Does it Matter?
When it comes to portfolios, it certainly does, but not necessarily the way you’d think. Bigger isn’t necessarily better here.
There are different views on how many stocks you should have in your portfolio, and they all depend on your investment strategy and goals.
For example, Peter Lynch said that you don’t necessarily need to own any more than 5 stocks at a time, and the famous Warren Buffet is widely known for his focused portfolio.
While owning a lot of stocks decreases your firm-specific risk, there is a catch.
You only need so many stocks to achieve the full benefits of diversification. After that, the benefits are marginal at best.
So, how do you know when you’ve diversified enough?
How Many Stocks Is Enough for a Diversified Portfolio?
The best explanation of portfolio diversification I’ve found is in Burton Malkiel’s book, The Random Walk Down Wall Street.
As Malkiel explains in his book, there is a point where diversification no longer offers the benefits you’re looking for.
For international stocks, you can get a well-diversified portfolio by owning around 30 to 40 different stocks. This would decrease your overall risk by about 60 to 70%.
Fortunately, there’s a bit of a twist: You can decrease your overall risk level by 50% with as little as 10 to 15 individual stocks.
These are obviously pretty rough numbers and estimates, but it would indicate pretty clearly that owning more than 15 stocks is unnecessary for diversification purposes.
So, perhaps Buffett and Lynch were on to something (surprise, surprise).
Of course, the example was only about stocks. You can, depending on your diversification strategy, include other asset classes like real estate and bonds to diversify even further.
Cons of Having Too Many Stocks in a Portfolio
Here’s a fun fact: Although Lynch has said that you only need a handful of stocks in your portfolio, he himself had over 1,400 stocks in his fund at one point. This is sometimes used as proof that you can also beat the market by owning a lot of stocks.
While this is true to some extent, we have to remember that Lynch operated a fund with a lot of capital – much more than a normal individual investor. It would not make much sense for a normal investor to purchase $100 or $10 worth of 1,400 different stocks.
When you own a lot of different stocks, the main issue usually is that it’s hard to keep track of the companies. Fundamental investing takes quite a bit of time and effort, and you simply can’t keep up with all that’s going on with your companies.
It’s also worth remembering that when you have fewer stocks in your portfolio, the stocks that do well have a larger impact on your portfolio. This unfortunately works both ways, so you have to be careful about what stocks you end up buying.
Another thing is that if you purchase a lot of stocks, the expenses like transaction fees start to diminish your returns. Therefore, if you feel the need to have a lot of companies, you might as well invest in index funds or other exchange traded funds and save the trouble.
Asset Allocation Tactics
As we’ve seen, too much of a good thing can be a bad thing. Now you may be wondering if you have to choose just one strategy.
Absolutely not.
There are no rules on how many stocks you should and can own. You can own anything you want in any way you see fit.
Here I’ve gathered three allocation tactics that I’ve found pretty useful and, at times, also profitable.
The Satellite Model AKA “Hard Core”
This strategy is usually known as a satellite model, and it’s a combination of passive and active management.
The idea is to form the core of your portfolio, let’s say 50%, by passive investments and seek extra returns from active investments.
I’ve used this one especially when I’ve invested in a new industry, like AI or Genomics, that has a lot of small promising companies with also a lot of risks.
What I’ve found a working combination is to form a sort of “mini portfolio” with one passive index fund and 3-5 individual stocks. Because of the risks involved, the passive core is around 50 to 60% and the rest is divided between the 3-5 individual companies.
Another way to do this with less risk is to replace individual stocks with mutual funds that are actively managed.
Personally, this is my favourite portfolio management strategy, since you can achieve the benefits of a balanced portfolio quite easily, yet still have the possibility of great returns.
Leave it to the Markets
The simplest way to invest is by investing regularly in passive index stock funds like the S&P 500.
When you do this, you don’t need to worry about anything. You get the average market returns without any fuss and let the stock market work for you.
If you don’t have a lot of free time or just don’t want to spend your time analyzing companies, this is the way to go.
Oh, and statistically speaking, you will do better than most investors by doing less, which is a win-win situation.
While this is the simplest way to invest, there are some things you should be aware of you avoid the most common mistakes in regular investing.
Buffett of Returns
This one is the opposite of the previous one. While a passive investor invests regularly and lets the market do its job, an active investor chooses the companies he owns.
The idea is to have a more focused portfolio with fewer stocks. This allows the possibility of beating the market and making great profits.
When we talk about investors that have made a fortune, they have usually done it with a focused style of investing.
The downside is that this is the most difficult of all the strategies. Building your own focused portfolio requires a lot of work, discipline, risk tolerance, and a truly long-term approach.
When you invest like Buffett (hence the name), you can make tremendous returns, if you can manage to keep your head straight and have picked the right stocks.
How Many Stocks Should I Have In My Portfolio?
So, as we have seen, there are several factors to consider when deciding your portfolio size.
The number of stocks you should own depends on your investment time horizon and strategy, risk tolerance, financial situation, and how much time you want to spend on investing.
If you’re willing to do the work and have been investing for some time, there’s no reason why you can’t have a focused portfolio of just a few stocks.
For the record, this does not mean putting all your eggs in one basket but rather making a well-informed decision of having a less-diversified stock portfolio.
When you do your homework well and manage to pick great companies, you can build a winning portfolio of 8-15 stocks.
When you build your stock portfolio with individual stocks, it’s worth remembering to not only diversify through different companies but also different sectors.
For beginner investors, it’s usually the wisest choice to start with passive index funds and see how it goes. When you’ve been in the market for a while and know how it works, you can start to analyze individual companies and make your first direct investments.
Sometimes it’s worthwhile to consult a financial advisor to help you to build your portfolio. Just be sure to choose the right one!
