What’s The Ideal Number of Stocks In a Portfolio?

What's the Ideal Number of Stocks in a Portfolio

What’s the Ideal Number of Stocks in a Trading or Investment Portfolio?

The Ideal Number of Stocks in a Portfolio is the key to a profitable investment strategy. And (no surprise) there are lots of conflicting schools of thought on what the ideal number of stocks to own in your portfolio is… so…

After years of stock trading and investing I have some very concrete thoughts on what the ideal number of stocks is to have in your portfolio.

What’s The Ideal Number of Stocks in a Portfolio to Diversify:

When it comes to the ideal number of stocks in a portfolio, there is a lot of conflicting advice. Traditional wisdom has it that diversity in your stock portfolio is critical. But while Ben Graham advocated owning small positions in hundreds of stocks, Warren Buffett is almost famous for the way he concentrates his stock picks to get the most return out of his best investment ideas. And we haven’t even talked about the colloquial saying that “there is safety in numberers.”

So who should you believe about the ideal number of stocks in your investment portfolio?

The best advice I have read about “the ideal number of stocks to have in a portfolio” comes from Joel Greenblatt in his legendary investing book You Can Be A Stock Market Genius. Greenblatt really cuts to the chase with his advice on portfolio diversity and the ideal number of stocks.

Here’s what you need to know…

A diverse portfolio of stocks does not protect you from market risk.  And here’s what I mean by that: Even if you own every stock in the S&P-500 you are going to have some days where the market goes up and some days where the market goes down. Right?

Think about it…

You cannot diversify away the portion of portfolio risk that comes from the day-to-day movements of the stock market. And given the interconnectivity of global financial markets and major economies, diversifying away from market risk is not something that is easily done. And I don’t know what your stock portfolio looks like or many how many stocks you own in it. But I’m wiling to bet most days your stocks are either mostly up or mostly down, correct?

On the other hand, having a diverse portfolio of many stocks does help you diversify away from non-market risk. Non-market risk is the risk of losing money in your stock idea because of something within the company (rather than the stock market at large). Non-market risk has more to do with the operation of your specific portfolio companies, like if a new product launch fails (think Blackberry), your oil well explodes (think BP) or your main factory burns down in a freak accident.

So you must be wondering…

What’s the Ideal Number of Stocks in a Portfolio to Avoid Non-Market Risk?

When you drill down into diversification strategy, and the ideal number of stocks in a portfolio, the math is actually quite surprising. Again, I’m drawing from Greenblatt’s book but I think you’ll find these insights into portfolio diversification very interesting. And you might even realize…

“The strategy of putting all your eggs in one basket and then watching that basket is less risky than you might think.”

For Example:

  • Owning just two (2!) stocks cuts your non-market portfolio risk by 46%!
  • 4 stocks in your portfolio cut this non-market risk by 72%…
  • 8 stocks in your portfolio cut this non-market risk by 81%…
  • 16 stocks in your portfolio cut this non-market risk by 93%…
  • If you have 50-500 stocks in your portfolio, there is a 2/3rd chance you will get a return of -8% to +28% on any given year
  • If you have only 5 stocks the range expands (a little) to -11% to +31% on any given year.

Those numbers are pretty alarming right?

It goes to show that having a lot of stocks in your portfolio doesn’t offer you much protection. You just need a couple of different stock ideas to eliminate non market risk from your portfolio. And by the way…

There’s one other factor that invalidates the folk wisdom about the ideal number of stocks in a portfolio…

Big Money Inflates the Ideal Number of Stocks in a Portfolio:

The truth of the matter is, mutual fund managers and big institutional investors have more stringent investment criteria than you or I. They also have a lot more money. And trying to allocate all of this capital is the biggest headwind to smart stock picking by big banks and pension funds.

Let me tell you what I mean…

When you have hundreds of millions (or billions) of dollars to allocate, you simply have to diversify your portfolio because of the amount of money you have. You can’t focus your entire portfolio on 4 or 5 companies because you would literally have to own the entire company to use up all your money.

So that’s the main reason why these massive money managers are so over-diverified – they simply have no where else to put their money! 

Now I know there isn’t a black and white answer to the question of how many stocks you should have in your portfolio. But hopefully this blog post provided some insight for you, and challenged the typical assumptions about portfolio diversification. And as for me?

I usually have 4-8 main positions based on my best stock ideas, and then a couple of small “leftovers” (where I have sold the main core position but want to keep a small number of shares just to keep tabs on the company). I also have some cash on hand and about 25% of my assets in index funds as a hedge against myself. This used to be a higher % but has diminished as I have raised more capital and gotten more confident with my stock picking.

The above approach to investing in stocks works well for me and I hope you’ve learned something. But now that I’ve shared my strategies for how many stocks I put in my investment portfolio let me ask you, what’s the ideal number of stocks in your investment portfolio? And if you’re still not 100% confident in the stocks in your portfolio sign up below in the form below for exclusive e-mail only analysis and stock ideas.

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