The answer to the question of the optimal number of stocks to own in your portfolio is that it depends. Frankly, this is almost always the answer to these types of investing and financial planning questions.
That said, the answer will vary widely among investors' various situations. For small investors, including those just starting out, the answer might be one or two. For more experienced investors, the answer might be a much higher.
Diversification – What Is It?
In layman’s terms, diversification means not putting all of your “investment eggs” into one basket. While this is often used in the context of investing in different asset classes such as stocks, bonds and cash, it also applies within the equity portion of your portfolio.
Imagine an investor with $100,000 to invest who put the entire amount in Apple (AAPL) - Get Report stock. If they had owned the shares over the past year, they’d be pretty happy with their investment. In 2019, the stock gained 88.09% versus a gain of 31.49% for the S&P 500.
However, this stellar performance has not always been the case. In 2018, Apple shares lost 5.12% for the year, slightly worse than the 4.38% loss for the S&P 500. In 2013, the S&P 500 gained 32.29% versus a 7.64% gain for Apple.
Are two stocks better than one? Again, it depends on the two stocks. Different stocks react to market factors differently. Further, different stocks will be subject to specific market and industry factors based on their industry, customer base and other factors.
For example, a growth stock engaged in technology like Apple will behave differently compared to a defensive stock like Johnson & Johnson (JNJ) - Get Report making consumer products a bit more resistant to the ups and downs in the market.
Can I Own Too Many Stocks?
Diversification among stock holdings is not just about owning as many stocks as possible. In fact, if you own too many different stocks, it’s likely that none of them will move enough to influence the performance of your portfolio for good or bad. Additionally, holding too many stocks makes it difficult to monitor their performance or any changes in the underlying company that might have an impact on your investment decision. Quantity is not a substitute for quality, and this certainly applies to the number of stocks you hold.
Focus on Quality
In building a stock portfolio, focus on quality over quantity. Look for companies with solid growth prospects that are are well managed. Also focus on your own investing objectives.
For some investors, buying dividend-paying stocks makes sense. These stocks can provide a source of income, and in the cases of stocks with regular increases in their dividend payouts, the underlying companies tend to be solid businesses.
Overall, it’s important to buy stocks in good companies, however an investor might define “good.” Additionally, it’s important to buy stocks in companies that you understand. That means understanding how the company makes money, and under what conditions it is likely to perform well.
Investors can find themselves with a concentrated position with just a few stocks. This might arise from stocks that do especially well over time, or it might be the result of owning a large amount of employer stock through stock-based compensation or employer contributions to your retirement account made with company shares.
On the other hand, concentrated positions in just a handful of stocks can lead to outsized returns, provided the investor is able to pick the right holdings.
Mutual Funds and ETFs
Many investors use mutual funds and ETFs for some or all of the stock allocation in their portfolio. These funds offer the opportunity to invest in a particular investment style, such as large cap, small cap, growth, value, foreign stocks, and so on.
Funds offer instant diversification within their investing strategy or asset class. It’s easy to build a diversified portfolio of stocks using funds. Index funds will track a segment of the market, while actively managed funds can offer the opportunity to outperform the market.
What Do the Experts Say?
Even among investing experts, opinions about the optimal number of stocks will vary.
In their book, "Investment Analysis and Portfolio Management," authors Frank Reilly and Keith Brown note that in one of their studies, "about 90% of the maximum benefit of diversification was derived from portfolios of 12 to 18 stocks.” The book quote, in turn, comes from a report from Morningstar that found owning more than 18 stocks in a portfolio makes it difficult for an investor to closely track the stocks in their portfolio.
Even among experts, opinions vary a bit.
· Burton Malkiel, author of “A Random Walk Down Wall Street,” suggests that it takes about 50 stocks to get the full benefit of diversification.
· Roger Nussbaum of Seeking Alpha and Gary Kaminsky of CNBC each suggest that the number is around 30.
· Legendary investor Warren Buffet tends to focus a high percentage of his portfolio in just a few stocks.
While these and other great investing minds all have a slightly different take on the optimal number, there are some common threads through their answers.
· Own a relatively small number of stocks. Trying to manage a portfolio of 50 or more stocks can be overwhelming for most individual investors, at that point you might be better off with an index fund.
· Understand what you won. This applies to individual stocks and to anything you might consider investing in.
· Own the stocks of quality companies. In investing, quality companies are generally the ones that are equipped to weather varying market conditions over the long haul.
So how many stocks should you own in your portfolio? As said at the outset, the answer depends. What I can say is that number should be manageable, it should be large enough to provide some level of diversification, but not so large that no one holding can provide a noticeable contribution to the overall portfolio.