If you’re a self-directed investor looking to build a portfolio of individual stocks, you may be wondering how many stocks you should own. While financial advisors often recommend diversification, the question of how much is enough and how much is too much still remains. In this guide, we’ll provide you with some detailed answers and insights to help you make informed decisions for your portfolio.
How Many Stocks Should You Really Own?
The common belief is that the number of stocks in your portfolio depends on its size. However, the size of your portfolio may not be as important as it seems. With the availability of fractional shares from popular brokerage firms, even investors with smaller portfolios can diversify across multiple companies just like those with larger portfolios.
“Studies show there’s statistical significance to the rule of thumb for 20 to 30 stocks to achieve meaningful diversification,” says Aleksandr Spencer, CFA® and chief investment officer at Bogart Wealth. “Personally, I think risk tolerance and aptitude for research should be the real driver. Depending on one’s risk comfort level, coupled with how deep into the weeds you’re willing to go, a more concentrated portfolio can be OK too.”
The Importance of Diversifying Your Stock Portfolio
The whole purpose of holding multiple stocks in a portfolio is diversification. By diversifying your portfolio, you hold enough securities so that a significant drop in one stock won’t cause a major hit to your entire portfolio.
For example, if you hold five stocks in your portfolio with 20% allocated to each position, a 50% decline in one stock will result in a 10% drop in the value of your portfolio. However, if you have 20 stocks in your portfolio, each representing about 5%, a 50% drop in a single stock will only translate into a 2.5% decrease in your overall portfolio value.
While diversification doesn’t guarantee complete protection against declines, it helps minimize the impact of a drop in any single stock.
How to Diversify Your Portfolio
Diversification goes beyond simply owning a certain number of stocks. It also involves spreading your investments across different areas of your portfolio. Here are some guidelines to help you diversify effectively.
In Stocks
It’s desirable to invest in different types of stocks to achieve proper diversification. Consider investing in growth stocks, which have a history of price appreciation and reinvest their capital back into the business instead of paying dividends. To balance this, include dividend stocks, which are more mature companies with a track record of both paying and increasing dividends. This combination offers a healthy mix of growth and income in your portfolio.
You may also want to incorporate a mix of large-, medium-, and small-capitalization stocks to take advantage of potential growth in different market segments.
In Industries
While you may believe in specific industries, it’s important not to concentrate your portfolio in just one or two sectors. Instead, diversify your holdings across several different industries.
“Consider investing in sectors like technology, healthcare, energy, financials, or consumer goods,” advises Jason Werner, investment advisor and founder at Werner Financial. This approach helps mitigate the risk of industry-specific downturns and offers a more balanced portfolio.
Maintain Balance in Your Portfolio
Regardless of the number of stocks in your portfolio, regularly rebalancing is crucial to maintain balance and avoid overrepresentation of certain positions. Rebalancing can be done annually, semiannually, or quarterly depending on your preferred strategy. It allows you to reset your portfolio to the original target allocation for each stock.
Periodic rebalancing also enables you to sell strong-performing stocks and book gains while buying weaker performers at lower prices. It helps prevent any single stock or industry sector from dominating your portfolio.
Don’t limit diversification to your stock portfolio alone. Consider holding a healthy number of fixed-income investments, such as bonds and U.S. Treasury securities, to add balance and stability to your overall investment strategy. Additionally, alternative investments through platforms like YieldStreet can further enhance diversification and potential returns.
If managing a large number of individual stocks seems overwhelming, you can also consider investing in exchange-traded funds (ETFs) for additional diversification without the hassle of managing multiple positions.
How Many Stocks Should You Own with $1K, $10K, or $100K?
The number of stocks you purchase is less dependent on the size of your portfolio due to fractional share investing. Instead, your investment goals and risk tolerance should be the primary considerations.
For high-risk-tolerant investors in their 20s, a portfolio of 10 to 15 stocks may be sufficient, given their long time horizon. On the other hand, investors closer to retirement may want to hold closer to 30 stocks to reduce the risk of loss if a few stocks underperform.
“Most beginning and small investors should focus on diversified, low-cost funds that track widely diverse indexes,” advises Robert R. Johnson, Ph.D., CFA, CAIA, Professor of Finance at Creighton University. Diversification is key, and investing in index funds can provide broad market exposure.
Too Many vs. Too Few Stocks: Pros and Cons
Let’s look at the pros and cons of having too many or too few stocks in your portfolio.
Too Many Stocks (Over 30)
Pros:
- No single stock will heavily impact your portfolio’s performance.
- Reduced risk of sudden and severe declines.
- More opportunities for diversification by industry sector and company size.
- Potential for tax-loss harvesting.
Cons:
- Managing a large portfolio can be time-consuming.
- A portfolio with many stocks may resemble a mutual fund and may not outperform the market.
- No guarantee against portfolio losses, regardless of the number of stocks held.
Too Few Stocks (Under 20)
Pros:
- Easier portfolio management.
- A small number of strong performers can significantly boost returns.
- Focused attention on top-performing stocks.
Cons:
- A few weak performers can severely impact returns.
- The portfolio may become dependent on a small number of high-performing stocks.
- Higher exposure to losses if heavily concentrated in one or two sectors.
“Most research suggests the right number of stocks to hold in a diversified portfolio is 25 to 30 companies,” adds Jonathan Thomas, private wealth advisor at LVW Advisors. “Owning significantly fewer is considered speculation, and any more is over-diversification. At some point, you may be better off purchasing an index fund that can rebalance in a tax-efficient manner.”
How Often Should You Swap Stocks?
The frequency of trading stocks depends on your investment strategy. If you’re an active trader, you’ll swap stocks as frequently as needed to generate short-term profits. However, if you’re a long-term, buy-and-hold investor, you’ll want to trade as little as possible.
Choosing companies with strong fundamentals and prospects allows you to hold positions for the long term, provided that the company profiles remain positive. Monitoring your holdings and staying aware of market developments are essential, regardless of your trading style.
If you lack the time or experience to build and manage your portfolio, consider seeking the assistance of a financial advisor. Platforms like WiserAdvisor can help you find the right advisor for your investment needs and preferences.
Frequently Asked Questions (FAQs)
Can you over-diversify a portfolio?
Yes. Holding too many stocks, such as 50 instead of 25, can reduce profit potential. At that point, it may be wiser to consider investing in index funds or sector-based funds for broader diversification.
Which sectors are expected to do well in 2023?
Given the uncertainty in the economy and financial markets, it’s challenging to predict specific sectors. However, focusing on companies with positive cash flows, low cost of capital, engaged industries, and the ability to raise prices in response to inflation may provide good opportunities.
What about the tech sector, which experienced a downturn in 2022?
Large-cap tech stocks could potentially bounce back, but caution is advised. Stocks in the energy and healthcare/pharmaceutical sectors may perform well, offering both upside in bull markets and defensive characteristics in times of volatility.
How do you compare different stocks?
Comparing stocks involves assessing their fundamentals and differentiating strong companies from weaker ones. Look for companies with low debt, high cash flow, good operating profit, revenue generation, and competent management. Consider criteria such as earnings, profitability, cash flow, debt, and operating margin to evaluate stocks.
Remember, investing involves risk, and it’s crucial to educate yourself and make informed decisions.