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.
The fact is, neither is a great approach. So, what’s the sweet spot? How many stocks should you own? How many is too many or too few?
It’s a question we get a lot.
There are pros and cons to owning either a small or large number of stocks. As with almost any investing strategy, the risk in either approach is on a spectrum.
It becomes a tradeoff between too much and too little exposure to individual names, and that changes not only your return potential but also how you manage your portfolio.
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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.
A single stock is too much concentration for any one portfolio, but that example helps illustrate the conundrum.
When your cash is spread among multiple investments, both the risks and the rewards are diluted.
If you had a portfolio of 10 stocks, your downside risk to any one position is the same, but the risk to your portfolio is lower.
If one of the companies were to go out of business, 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 as one position rising 300% would lift your total portfolio by only 30%.
That leads us to the question of how many stocks you should 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.
Now, that does come with a caveat. Twenty large-cap stocks may be enough to maintain diverse exposure to that asset class, but then you’re left without small-cap stocks, mid-cap stocks, or international stocks.
If you wanted a diverse portfolio that spans market capitalizations, you would need dozens and dozens of individual stocks.
That’s impractical for even the most seasoned investor. But it’s also a relatively straightforward problem to solve.
Using ETFs to cover asset classes outside of your preferred arena is an easy way to increase portfolio diversification.
A small-cap ETF or index fund can take care of your exposure to smaller companies if you’re primarily a large-cap investor.
By that same token, if you prefer to invest in small-cap names, you can use something as simple as the S&P 500 ETF (SPY) to tick the large-cap box off in your portfolio.
Modern portfolio theory argues that you want some degree of exposure to large-cap stocks, small-cap stocks, international stocks, bonds, and cash.
You can also get more granular and break those categories down into growth or value, or you can get sector-specific.
For a typical investor, having diverse exposure to the market through a combination of ETFs and then adding exposure to your preferred asset class with individual names is a solid way to play it.
That way, instead of managing a portfolio of small-cap value names, for instance, that you’re not engaged with, you can let ETFs do the heavy lifting there and focus on managing the large-cap growth portion of your portfolio. That’s also a smart way to integrate Cabot’s advisory services into your portfolio. Instead of individually managing your growth stocks, you can use Cabot Growth Investor to cover that portion of your portfolio.
That offers the benefit of diversification while allowing you to take more concentrated (and intentional) risk in individual stocks that you can research more diligently, or that you’re more comfortable with.
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