The more things you invest in, the less you can lose if an individual investment turns out to be a dog. And let’s face it, even the very best investors end up owning a few mongrels. At the same time, you need to keep your investments manageable, meaning there’s not too much to track. So what’s the right balance between spreading the risk and keeping the workload in check? Specifically, when it comes to the stock part of your investments, how many different stocks should you own?
A reader wrote to me with the following question:
I’ve been thinking about a few questions in regards to owning the stocks per your recommendations.
Is there a certain number of stocks you should hold in your portfolio? Let’s say 10-15 stocks. Doesn’t it get unmanageable if there are too many stocks?
What about, let’s say, buying 8-10 stocks and keep adding more shares? I could always take the cash dividends and manually buy more shares.
Just wanted to get some feedback from you.
George T., California, USA
Thanks to George for the questions, which are good ones. Essentially there are two issues to address:
- How many stocks to own
- Whether and how to reinvest the cash from dividend income.
Today I’ll start to answer the first question, with a follow up early next week (in the interest of brevity). Later next week, I’ll deal with the right approach to putting dividend income to work for the best results, since it’s a whole, important topic in its own right.
There are no free lunches in the world of investment, but the benefits of diversification are probably as close as you can get to one.
Diversification is simply the idea of not putting all your eggs in one basket, in case the handle breaks. The more you spread your money around, the smaller the risk of getting wiped out by unforeseen events.
Any investment can go wrong. Many do. So it’s pretty obvious that if you have all or most of your money in just one thing then you’re running a huge risk.
Some people’s risk averse reaction is to sit on bank deposits, or similar. These are seen as low risk. But deposits will always make a very low return in the long run.
Even worse, once income taxes have been levied on interest income, and consumer price inflation has eaten away at buying power, sitting on too much cash – and holding it for too long – is actually one of the riskiest things that an investor can do.
This is why investment in higher return assets, such as stocks, is so essential. But stocks come with risks of their own, and these must be managed.
Also – and I can’t stress this enough – diversification just for the sake of it is a bad idea.
Over the long run, owning a lot of assets with a poor profit outlook will clearly reduce returns, not improve them. A good example, right now, would be a large allocation to ultra low (or negative) yield bonds, such as those found in Japan and many European countries.
Each individual investment must be held for a good reason. Usually that’s about profit potential over the long or short term. Sometimes it’s for tactical reasons, such as hedging a stock market crash with an allocation to cash or long dated US treasuries.
In short, you need to diversify, but you need to diversify well. Everything you invest in should be owned for good reasons, not just because it’s different to your other investments.
Currently, you can see from the table that I recommend a 40% allocation of financial investments into stocks – but only where prices are sensible.
Ordinarily, I’d like this allocation to be higher, given that stocks are such a great source of long term profit. But a lot of stocks are richly priced these days, especially in the huge US market, hence the relatively cautious stance.
You have to pick and choose carefully these days. Fortunately, it’s a big world, and there’s always something that’s attractively priced.
Whether you have 40% of your investments in stocks…or 10% or 90%…how many should you own?
I usually recommend at least 20 stocks, and up to 30, built up over time. But there’s no hard and fast rule.
There are situations when that can be safely lower, and more in line with George’s suggestions of 10 to 15, or even 8 to 10. Where you end up comes down to personal preferences, and how you invest overall.
On which note, the monthly OfWealth Stock Investor report is dedicated to identifying the best stock opportunities that I can find. The first two recommendations have already achieved dollar gains of 11.6% (since November) and 10.4% (since December). In both cases, I believe the eventual upside potential is far greater.
Eventually, my intention is to build this into a portfolio of around 20 of my best stock ideas. (Click here if you’re interested in becoming a member, and would like to learn more.)
Part II will explain in more detail how I arrived at these figures for how many different stocks you should own. Look out for it next week.
Stay tuned OfWealthers,