For diversification purposes, at what point do you feel enough is enough as far as the number of stocks is concerned?
Being properly diversified is critical for controlling risk. However, you have to balance the need for diversification with the time required to monitor your holdings.
If you own only a handful of companies and one of them blows up, it could put a serious dent in your wealth. On the other hand, if you own, say, 100 stocks, you’re going to find it hard to stay on top of corporate developments.
So, for most people, the ideal number is somewhere in the middle.
In his influential 1949 book, The Intelligent Investor, Benjamin Graham argued that a portfolio of 10 to 30 stocks provides adequate diversification. Mr. Graham didn’t pick stocks at random, of course. He subjected them to careful scrutiny and insisted on buying them at a price that provided a “margin of safety,” thus complementing the benefits of diversification.
Other studies have indicated that, if stocks are chosen at random, an investor would need 50, 100, or more in order to have similar volatility to the market as a whole. The number of stocks required for proper diversification is a subject of debate.
“The academics disagree over how many separate stocks are required to secure the benefits of diversification, but most professionally managed equity portfolios have at least 30 or so individual securities in them,” U.S. fund manager Daniel Peris wrote in his 2011 book, The Strategic Dividend Investor.
That said, I’ve spoken to portfolio managers who are comfortable holding fewer than 20 companies at a time.
In my Strategy Lab model dividend portfolio, I have 12 securities – 11 stocks and one exchange-traded fund. I’ve said before that this doesn’t provide adequate diversification, but it was the maximum number the Strategy Lab participants were allowed.
In my personal portfolio, I have 34 holdings – including four ETFs and one mutual fund. I don’t feel the need to add any more securities (in fact, sometimes I feel that’s too many!). If I have new money to invest I just add it to one of my existing positions when I consider a stock to be cheap.
With diversification, the number of holdings isn’t the only factor to consider. If you have 50 stocks but they’re all gold producers, for example, you won’t be properly diversified. You need to spread your money across various sectors – and, some would argue, geographies – so that if a problem strikes one industry or country your portfolio won’t suffer undue damage. Another important consideration is the risk profile of the companies themselves.
As a buy-and-hold dividend growth investor, I am not looking to trade in and out of stocks; rather, I am aiming to hold companies for years or decades and collect the rising dividends. With that goal in mind, I focus on large, blue-chip companies – banks, pipelines, telecoms, utilities and well-known consumer stocks, for example – that don’t require a lot of monitoring. I can basically put them away and not worry about them. This allows me to enjoy the benefits of diversification without having to do a lot of extra work following every little company development. If I were investing in higher-risk stocks, I would have to do a lot more research.
One final point: Not everyone is comfortable selecting individual companies or monitoring a portfolio of stocks. For these folks, exchange-traded funds are an ideal solution: They provide excellent diversification and require very little monitoring. The tradeoff is that the ongoing costs are a bit higher, and you won’t have as much control over what you invest in. When it comes to diversification, I like to get the best of both worlds. That’s why I own individual dividend-paying stocks and supplement them with ETFs.