How many stocks should you own? Not too little. Not too much. Here’s how to find the sweet spot.
When you’re building your investment portfolio, it can be tempting to fill it with every promising stock that comes along. It can also be tempting to put everything into just a few stocks that you think will skyrocket, making you wealthy. The fact is, neither is a great approach. And also, either is a great approach. We’ll explain in a minute, but with any approach, how many stocks should you own? How many is too many or too few?
It’s a question we get a lot. The fact is, there are pros and cons whether you own a small or large number of stocks. As with almost any investing strategy, the risk in either approach is on a spectrum. There’s no such thing as 100% risk-free investing, although you can keep your risk to a minimum, just as you can expose your portfolio to a lot of risks. Let’s jump into the details.
The pros and cons of owning more or fewer stocks
The math is pretty straightforward: If you invest most of your cash into, say, one investment, and that investment quadruples, you now have four times more money than you did. Alternatively, if that investment sinks by half, you now have half the money you started with.
When your cash is spread among multiple investments, both the risks and the rewards are diluted. In the above scenario, if you had your money distributed evenly across ten stocks, you would only lose 10% of your cash. That’s not ideal, of course, but it’s way better than losing everything! On the flip side, you also won’t get the reward of quadrupling your portfolio.
Some investors are comfortable with these types of odds. For them, four or five stocks feels right. You may prefer to hold a dozen or more to minimize that type of risk.
That leads us to the question of how many stocks should you own? We’ll assume that you want to make gains without putting all your money at risk. So, where is that sweet spot where a couple of stocks can pull your entire portfolio up while also minimizing your risk of a devastating crash?
How many stocks should you own to minimize risk and maximize profits?
Let’s quickly address the diversification myth. In reality, the benefits of diversification are substantially reached when an investor owns around 20 to 30 stocks. That’s not to say investors shouldn’t own more than 30 stocks. But if they do, they should do so knowing that the incremental portfolio diversification benefit of each additional stock goes down after that 20 to 30 stock threshold is crossed.
That’s especially true if they are blindly buying dozens if not hundreds of low-quality stocks, which is what arguably happens when you purchase anindex fund.
That said, you can and should diversify your holdings, but you can do that even with just a handful of stocks. Start by making a list of industries (financial, tech, energy, etc.). Then write down a few names from each category. Next, do your research and narrow down your list. Select five to 10 stocks, one or two from each industry on your list. Voila! You have a diversified portfolio of profitable companies. It’s that easy.
Again, the fewer stocks you own, the more one or two stocks can impact your earnings, positively or negatively. That impact diminishes, for better or worse, with each stock you add to your portfolio. Balancing these two opposing forces is the challenge. And ultimately, you are the only one who can answer that.
We’re happy to help you make smart choices, no matter how many stocks you prefer in your portfolio. Browse the cabotwealth.com website and then take a look at our 15 investment advisories, where our analysts routinely pick winning stocks that beat the market year in and year out.
How many stocks do you hold in your portfolio? How did you come to that number? We’d love to read your answers in the comments below.