Are You Making the Same Mistake I Am?

I've become aware recently of a not-so-great habit I've gotten into in my investing: When I decide to invest in a company, I often buy too little of it.

It wasn't always this way, though. Let me explain, with some simple round numbers. Imagine that in my early investing years, I had a portfolio worth a total of $100,000. (In reality, I started out much smaller.) So I'd routinely buy, say, $3,000 to $5,000 worth of a stock at a time.

Even this wasn't perfect, because a $100,000 portfolio could have 33 $3,000 investments in it, or 20 $5,000 ones. Owning 20 to 33 different stocks can be problematic for several reasons:

• It's hard to really keep up with that many companies. If you own 25, will you read every annual report? Every quarterly report? Will you be able to follow developments for all of them in the news? Most of us don't have the time for that.
• Our money stands a better chance of growing quickly if we concentrate it on our best ideas. Think of the 10 stocks that are most compelling to you. Now think of the 10 next most compelling stocks, and the 10 after that. Why put money into your 29th-best idea, when you could simply add more to your best or second-best ones, where you're more confident?

Buying certain numbers of shares may reinforce a habit like this. Given that many stocks trade in the same general range, it may seem simple just to buy 100 shares of everything. But see what happens if you opt to buy 100 shares apiece of the first seven companies in the Dow:

Data: CAPS. Fool.com.

See? If you have equal faith in 3M and Alcoa, you'd be spending more than five times as much on one of them as on the other.

My problem grew bigger as my portfolio grew bigger, because I was still used to buying around $3,000 to $5,000 of a stock, and often just 100 shares of it -- even when my portfolio was worth, say, three times as much. In a $300,000 portfolio, a $3,000 investment is just 1%. Ask yourself if it's really worth putting just 1% of your money in something you have a lot of faith in. There's a real danger of spreading yourself too thin this way. With a $300,000 portfolio, I should think about buying perhaps $10,000 of a stock (or mutual fund) at a time, if not $12,000 or $15,000.

What to do
So take a few minutes to look at how you're investing, and how you want to invest. Consider limiting yourself to just 12 or 15 of your best ideas.

If you're tempted to really focus your portfolio, on perhaps 10 or fewer stocks, be careful. Concentration's power will be strongest if you're studying each pick closely and are very confident in each. If not, then greater diversification can serve you well. My colleague Rich Greifner has explained what happens when you're over-concentrated in one stock. Such focus can really enhance your returns when your picks do well, and can wound them when they don't.

If you have fewer than 10 or 12 stocks in which you want to invest, an easy way to get diversification is to add some mutual funds to your mix. If your picks are mostly large caps, you might add a small-cap fund or two. Or maybe add an internationally oriented one.

But if you feel comfortable putting together a perfectly sized portfolio, then have confidence in yourself by taking good-sized positions in each of your stock picks. Over time, your courage should pay off.