How much stock exactly one should keep in his portfolio? Number of stock that you should keep. Question that is in there in every investors mind. But, everyone has different answers. In this article we will tell you healthy number that you should have your eye on.
Almost everyone who wants to invest in has some kind of strategy to pick a stock and invest in it. Some actually think and invest while others hear from somewhere and pick stocks and of course stock market is so tempting they end up investing in it without giving second thought. Whatever it is. But, main thing in which even smart investor tends to become loose is when story comes to portfolio allocation. And yes, picking up and investing in stock market is one skill while portfolio allocation is another thing. And the main secret that can lead you to become good investor is money management. And I have seen many many people who are really good at picking up stock but bad at portfolio management.
And portfolio management starts with determining how much stocks you should keep in your portfolio. So that you can allocate money to be invested particular stock.
And if we are talking in percentage format then one successful investor and author Seth Klarman once said, “For any investor, it is safe to say that no single stock should be more than 5-6% of the entire portfolio. This is Rule No 1 of stock investment. Whatever the other rules are, Rule No 1 always holds true. In the book titled, the “Intelligent Investor”, Benjamin Graham has mentioned that one can build a perfectly diversified equity portfolio with 10 to 30 stocks. Again, this numbers are average. Whenever you say investor it may mean person with 1000 dollars portfolio or the person with trillion dollars portfolio. So the number of stocks can’t be the same with for everyone.
However, you need to understand that the number of stocks in one’s portfolio is not about “random investing”. In fact, equity investment is anything but random investing. Everyone has their own styles of investing and hence need to choose the stocks according to his own risk appetite and sector preference. For example, an aggressive investor may opt for growth stocks while a sector biased person might opt for a heavy exposure in a particular sector. The truth is that there is no one size fits all solution and many factors need to be taken into account to arrive at the ideal number of stocks in your portfolio. So, there are Factors that should be considered while opting for the ideal number of stocks in the portfolio.
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- Tolerance to risk: which is an obvious factor that needs to be accounted for: Your own tolerance to risk. How much risk you are ready to take while investing in stock market. It would help you choose an industry, sector, stock, etc. once you are aware of your own risk appetite.
Let us understand this with an example. If the stock of one company tanks or underperforms, the impact on your overall portfolio is minimal if the percentage holding of that particular stock is low. Hence, the first rule of investment holds true here. Thus, once you know your own tolerance to risk, you can opt for traditional large-cap stocks or value stocks or even growth stocks. - Returns Expectation:
Next factor is how much return do you expect while investing in market. As the number of stocks in your portfolio increases, the overall returns on your entire portfolio usually decreases. This is because some stocks in the stock market usually out-perform the others while most stocks give an average return. So, the high returns of a few good stocks average down due to the performance of other stocks in the total portfolio. So, higher the return expectation lower should be the diversification, so that you can concentrate on certain companies only, provided you have complete confidence in them. Best example here is Berkshire Hathaway’s Apple stock which forms 44% of entire portfolio. While stock like American express has around 6% allocation in Berkshire Hathaway portfolio. That denotes warren buffet has more confidence on Apple than American Express. And that paid of as Apple has given tremendous amount of profit to Berkshire than any other stock in his portfolio in short period of time. - Research:
Apart from this lot of things also depends on your research before investment. Like Quality of research and quantity of information you gather before making an investment play an important role in the diversification of stocks in your portfolio and to decide how many stocks should you buy. Whenever it comes to research people get confused what to look for as there are a number of aspects that you need to consider for your research like: - Company’s Fundamental:
The company’s fundamentals: I mean Fundamentals need to be analyzed before opting for the stock which includes earnings, profitability, projected cash flow per year, annual reports, performance and operating margins. There are lot of things that need to be considered here. Remember, opting for a company is like marrying the same. You need to be 100% confident in the growth propositions of the company and then choose to be a part of the same. Higher the operating margins, the higher is the efficiency of the company.
Your research should include analysing Capital Structure: Capital structure of the company is an important parameter. A conservative capital structure is a good indicator of stability and liquidity so that the company’s dependence on long-term debt is low. And investors love company with low debt and higher profit.
Now next is management. Management is a key performance indicator of the company and a stock performs well only if the management is focussed and growth-oriented. So, research about management is also of the utmost importance. If you have researched well then you can focus on a concentrated portfolio to maximise returns.
And you should also consider the time period in which you are going to hold the stocks. Because, Stocks give the best returns over the long-term. Some stocks do give overnight returns also, but that is not a sustainable portfolio. And Value investors who wish to create a healthy stock portfolio should not depend on overnight returns. Equity is a long-term investment and most people use the ‘buy-and-hold’ for the same. And I would like to suggest to you people from my personal experience that The higher the duration of your investment, the lesser you need to diversify your portfolio to maximize returns. Because it is observed that company usually need years to grow its profit and to win the trust of the consumers, so over a period of time its share price will also increase as it starts giving solid revenue numbers.
- Importance of Cash Buffer: More than the ideal number of stocks in a portfolio in USA, the trickier question is the level of diversification. While some investors believe that they should remain invested 100% of the time, others like to have a healthy cash balance for investment opportunities that might come at any point in time. Because, USA is heaven for companies and new businesses and lot of people love to list companies from all over the world in USA. However, the financial crisis situations have proved beyond doubt that being 100% invested at any point in time might not be a great solution as a crisis can come without prior notice and the correction might be much lower than your risk tolerance. At this point withdrawing your investments may lead you to incur a loss. And probability of this being happening is very high in such crisis. So, having a cash buffer is a healthy habit. So, having 15-20% of your portfolio cash balanced is always a good idea to maintain your healthy portfolio and it also gives you a buffer to even invest when the market tanks where most of the big investors try to buy. Remember the quote of warren buffet that when people sell he buys. So, you must consider cash keeping in your buffer. And this is how it also effects on number of stocks in your portfolio.
So in Conclusion, for most investors the number of stocks in their portfolio should ideally between 15 to 25, depending on the investment strategy and portfolio size. The investment strategy also determines how many stocks you should own; whether you want a concentrated portfolio of high dividend-yielding blue-chip stocks or if you are investing in high growth small cap stock or in another strategy of you want portfolio to diversify it to a larger number of stocks to lower the overall risk of investment. Its individual’s choice and only you can choose your style of investment
So on and on The final decision is actually yours. Joel Greenblatt ,a value investor and author of the famous book ‘The Little Book That Beats the Market’ says,“Over the short term, Mr. Market acts like a wildly emotional guy who can buy or sell stocks at depressed or inflated prices but over the long run, it’s a completely different story: Mr. Market gets it right”. And he does have a point. There is lot of noise and mixed sentiments of investors of you start lowering your time horizon. So, go ahead, diversify but not overdo it as the stock market does know how to play it right anyway.