What Is the Ideal Number of Stocks to Have in a Portfolio?
Despite appearances, the question of how many stocks are ‘Best’ has no single ‘right’ answer.
How many stocks to hold in your portfolio is ultimately a very individual affair, from the country you live in to your time horizon, the state of the market, or any number of other factors – and how closely you like to follow financial news.
Key Takeaways
Diversification is critical to achieving long-term returns while limiting risk.
The precise number of investments in a diversified portfolio depends on the individual.
For the most part, redundancy is uneconomic. Having many high-paying stocks, for instance, or many growth stocks adds to your costs with little reduction in risk.
Understanding the Ideal Number of Stocks to Own
Investors diversify because one of the main reasons for doing so is to manage risk. Diversifying lowers the part of the investor’s risk that is strictly tied to a particular company or industry, which is technically known as unsystematic risk.
It is impossible to lower the risk in a portfolio to zero. There will always be the risk that the entire stock market will be hit by an economic downturn. But academic research on the subject of modern portfolio theory has demonstrated that a sufficiently diversified portfolio of equities can bring unsystematic risk almost down to zero, while keeping the same level of expected return that a portfolio with excessive risk would have delivered.
In other words, investors accept more systematic risk for the prospect of higher return (the risk-return tradeoff), but they don’t generally benefit from higher return potential for bearing unsystematic risk.
If the number of equities in your portfolio is high, then your exposure to unsystematic risk will be low. First, let’s recognise that a portfolio of 10 or more stocks is (usually) much less risky than a portfolio of only two stocks (even if those two stocks are different). If you are holding different stocks within different sectors or industries and, in particular, different geographical areas, then your portfolio’s risk will shrink even further.
Consider Funds
But the transaction costs of holding more stocks accumulate, so it is best to hold only the number of stocks needed to eliminate the stocks’ exposure to unsystematic risk.
It is a measure of something – but what? There is no agreed answer, but there is an agreed range.
A good diversified equity portfolio can reduce unsystematic risk to almost zero at nearly no cost in terms of the expected long-term return to the investor.
More recent studies indicate that retail investors can now hold as many stocks as they want (thanks to barely existent transaction costs from online brokers), but there is a time-cost fallacy and most investors find their portfolios perform as well (or better) using an online broker and buying most ETFs.
If you’re daunted by the thought of having to research, choose and monitor a string of separate stocks, index mutual funds or ETFs offer rapid and easy diversification across broad groups of sectors and market capitalisations, so that you can buy hundreds of stocks in one fell swoop.
How Many Stocks Should You Own for a Diversified Portfolio?
There’s no single correct answer but, broadly speaking, an investor will want to hold stocks in more than a few different sectors, with at least some portion of his or her wealth in fixed-income instruments, which I define as bonds or other instruments whose dividends are fixed and paid out regardless of wider market movements. Those fixed-income instruments will form the backbone of the investor’s portfolio and will act as a bulwark against falling stock markets.
This usually consists of at least 10 stocks. Note, however, that many mutual funds and ETFs hold shares in a cross-section of stocks – the S&P 500 Index or the Russell 2000 Index, for example.
How Many Stocks and Bonds Should Be in a Portfolio?
The ultra-aggressive plan would put 100 per cent of the stocks into your portfolio. A moderately aggressive strategy includes 80 per cent in stocks to 20 per cent in cash and bonds. Keeping 60 per cent in stocks but 40 per cent in cash and bonds is a moderate growth plan.
A conservative approach calls for investing no more than 50% in stocks.
A rough guideline is to reduce the percentage of stocks in your portfolio and increase the percentage of high-quality bonds as you grow older.
This shields the investor from adverse market fluctuations by ensuring that, even if markets fall, the investor has time to recover. For example, someone at age 30 might have allocations containing 70 per cent stocks and 30 per cent bonds – because a 30-year-old has time to regain the value following a market downturn, unlike a 60-year-old for whom stocks allocate a lower share of the portfolio and bonds dominate, with 40 per cent stocks and 60 per cent bonds.
How Many Stocks Should I Own With $10,000?
What all these individual investors are doing is using ETFs to diversify into a whole sector, and as a result they are investing in hundreds if not thousands of companies, rather than just 10 or 20 individual companies.
10,000 dollars invested in several ETFs translates into exposure to thousands of names.
The Bottom Line
A balanced portfolio doesn’t take hundreds of stocks and bonds to work. It takes dozens of choices, a mix of risk and safety. A mix of good and bad choices too. That’s the best way you can meet your financial goals.
If you like the idea of increased diversity but don’t want to put the time and effort – and perhaps the expense – of owning an individual stock or bond portfolio, you can still gain much more diversification than most of us could possibly do for ourselves by owning a mutual fund or exchange-traded fund. A good choice of these will provide you with considerably more breadth than any individual investor could otherwise possibly attain.
