Believe it or not, there is a time when you should put all your money into just one stock: When you're absolutely sure it will grow as quickly as you want it to. Unfortunately, the times when you can be absolutely sure about something like that are ... rather nonexistent.
So what's an investor to do? Well, the answer is simple, and you probably know it already: Diversify. The next question investors might ask is: Just how diversified should I be? And my answer to that is: It depends.
I've often recommended that people aim to hold between, say, eight and 15 stocks. I reason that if you have much fewer than that, you're putting all your eggs into too few baskets, and a lot is riding on each basket. If, on the other hand, you own many stocks, it can be hard to keep up with them all, and ideally, you should keep up with them all. (By that I mean review their quarterly earnings and annual reports at a minimum, and follow them in the news regularly, if you can.) So for most of us, eight to 15 seems reasonable.
So that's one way to think about it. Another way is to focus on the confidence factor.
The confidence factor
To understand what I mean by the confidence factor, let's say you've researched several dozen stocks and have found 10 that you like. How do you distribute your money? Well, if you're very, very sure that one will do the best, then you'd put most of your money there. That's the confidence factor. Put the most money behind your best idea.
But could you really be sure you know which of your ideas is the best? Super-investor Peter Lynch couldn't. He is reported to have quipped that if he likes 10 particular stocks, the one that ends up rising the most will always be a surprise.
Look inward
Now take a moment to think about your own portfolio. How many stocks do you own? How confident are you in their futures? How much research have you done on them?
If you peeked into my own portfolio, you'd see a lot of stocks. But that's a problem. I haven't taken the time to keep up to date on all of them, and if you asked me today, I wouldn't be able to tell you which are my best ideas.
But I've come to terms with my lack of time. That's why I'm now more invested in mutual funds than ever before.
Funds can focus
And if you think mutual funds might be for you, don't assume that means you have to give up on the idea of concentrating your portfolio on your best ideas. There are actually plenty of funds out there that concentrate, or "focus," their own holdings.
One example is the young Tilson Focus (TILFX) fund, run by former Fool contributor Whitney Tilson. The fund has just 21 holdings, including McDonald's
In fact, according to a study cited in this SmartMoney article, "concentrated portfolios slightly outperformed -- even on a risk-adjusted basis -- their diversified counterparts." And that makes sense. By making big bets on the best stocks, focused fund managers should be able to deliver outsized returns (though when they're wrong, the losses can be outsized, too).
The Foolish bottom line
All of this is to say that if you're interested in investing in a concentrated portfolio via mutual funds, you really need to do your homework when it comes to the fund's manager. Ideally, you'd like to see a manager with long and successful track record investing alongside an ownership position in the fund that she heads up.
And that's where our Motley Fool Champion Funds service can help. By taking advantage of a 30-day free trial, you can read about the focused funds that analyst Shannon Zimmerman is recommending today and see how they fit into his risk-adjusted model portfolios.
But no matter how you choose to invest, always make sure that your portfolio reflects your confidence -- or lack thereof -- in your holdings.
Longtime contributor Selena Maranjian owns shares of McDonald's, Microsoft, Costco, and Wal-Mart. Microsoft, Dell, and Wal-Mart are Motley Fool Inside Value recommendations. Costco, Dell, and Pacific Sunwear are Motley Fool Stock Advisor picks. The Motley Fool is Fools writing for Fools.
