Investors may wonder how many different stocks they should have in their portfolios to be properly diversified, and while the answer varies for each situation, here are some good guidelines to follow.
It all has to do with diversification, and that basically just means having enough variety within a portfolio so that if some asset class suffers a hit, another one is there to offset the blow. Typically, diversification is used in the context of asset classes (the big three being stocks, bonds and cash), but it can also apply to a particular asset class, like equities.
Looking at a single stock like Apple (NASDAQ: AAPL) shows while it had amazing returns in 2019 when it gained 88.1%, only a year after the stock managed to lose 5.1%. So while Apple struggled in 2018, there was a different stock that could have been in the portfolio to offset some of those losses.
While it’s important to diversify, it’s also crucial to make sure you understand how different stocks will react to certain market action. Growth stocks like Apple are going to have bigger swings than defensive stocks like Coca-Cola because the latter has matured over the decades the company has been around.
Quality Is Key in a Stock Portfolio
It is possible to own stock in too many different companies, which can mean any movement by a particular stock doesn’t really affect a portfolio in any direction because money is spread too thin. It can also make it much harder to truly understand a company when it’s one in a group of 100 or more.
Focusing on a smaller number of quality companies will lead to a greater understanding of those companies, how they make money and how they react to market conditions. Quality companies also have a greater chance of recovering from a big market drop.
Using Funds and ETFs to Boost Diversification
One way to achieve instant diversification is through investing in a mutual fund or an exchange-traded fund (ETF). This way someone can target a particular investment strategy used by the fund’s managers like focusing on small cap or growth stocks.
Because funds are made up of a group of assets or stocks, it’s easy to gain the benefits of diversification by investing in them. Looking at funds, it’s important to know how their investment styles differ. Index funds will follow the trends of a particular market segment, while actively managed funds try to find ways to outperform the overall market.
Experts Weigh in on Stock Portfolio Size
Professional investors can’t even come to a consensus on how many stocks should be in a portfolio.
Frank Reilly and Keith Brown wrote in their book “Investment Analysis and Portfolio Management” that “about 90% of the maximum benefit of diversification was derived from portfolios of 12 to 18 stocks.” The Morningstar report their study was based on found that owning more than 18 made it hard for an investor to understand and track each stock individually.
Economist Burton Malkiel thinks owning around 50 stocks is necessary to take advantage of the benefits of diversification, while Seeking Alpha’s Roger Nussbaum and CNBC’s Gary Kaminsky think the magic number is 30.
Even as the opinion on the ideal number of stocks varies from expert to expert, there were some common themes among their strategies. Per The Street:
- Own a relatively small number of stocks.
- Understand what you own.
- Own quality companies.
So while the ideal number of stocks to own in a portfolio varies from investor to investor, the biggest thing is to make sure it is a manageable number, while still providing the benefits of diversification.
