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How Many Hidden Gems Are Enough?

Hi, Dayana. I'm aMotley Fool Hidden Gemsnewsletter subscriber with a quick question: I have about $1,000 to invest every month because I'm living at home right now. Do you think it's better for me to scoop up about 15 to 20 small caps that I think are good picks, or do you think that I should concentrate among a smaller pool of small caps -- maybe five or six? I'm a recent college grad and thinking about the best way to start my investing career. Thanks for your help. -- Jonathan

Hi, Jonathan.

My jester hat goes off to you for taking the investing plunge so early in life, when you could still get away with blowing your money on Beer Pong and a convertible.

But seriously ... on to your question. The easiest way to end up with underwhelming investing returns is to spend too much. If you are regularly adding to your positions (a.k.a. "dollar-cost averaging" into the stocks) as opposed to plunking down one lump sum, you must closely watch your expenses. Every time you trade, you generate a commission, so adding small sums of money to 15 to 20 stocks a month could really dampen your returns. Say you pay $10.99 a trade (that's the going rate at Ameritrade) and add to 20 positions. That's $219 less you have to invest every month -- more than 20% of your available investing capital.

In general, you want to keep expenses (which include subscription costs to money rags and Fool newsletters) to less than 2% of your overall portfolio's value. Way less, if you ask most folks around here. Using the same scenario as above, that means that every time you trade, the minimum you can invest in a stock to follow the 2% rule is $549. If you qualify for $5 trades (that's what BrownCo offers those who have at least $5,000 in their IRA), you can buy four positions per month.

No, this kind of bookkeeping is not as sexy as actually finding those Hidden Gems. But it is an important part of getting the best return on your cash.

Another consideration before you start counting off stocks is your psychological bandwidth. Even with a buy-and-hold approach, you have to keep up with company goings-on. This goes double for smaller, lesser-known companies where the effects of earnings, news, the CEO's dog's temperature, etc., can have an amplified affect on the stock's price.

The Hidden Gems team keeps on top of its picks full-time. (And by extension, so do you, if you visit the dedicated discussion boards offered to subscribers.) But once you begin finding your own "Gems," you'll be chief researcher, reporter, and scribe, which will then raise the question: How many companies can you track and still have a life?

Tom Gardner has said that when you buy into the S&P 500 index mutual fund, you get about 485 more stocks than Warren Buffett thinks you need in your portfolio. So is the perfect portfolio size 15? Is 15 stocks is all you should ever own? Perhaps. Or even fewer, if you really know your companies well and follow them with fervor. Undiluted, your winners really make your portfolio shine.

But we're not all Warren. Some of us occasionally pick clunkers. A diversified portfolio helps maintain some balance. Simply devoting a portion of your investible assets to the S&P 500 index mutual fund may be all you need to keep your portfolio from capsizing.

You're young. You need less sleep than the rest of us. You've got years to weather the market's ups and downs, and years to build up your portfolio and investing know-how. You'll probably have plenty of time left over for Beer Pong, too.

Every month, theMotley Fool Hidden Gemsnewsletter analystsgo where Wall Street won't, looking for terrific but boring businesses the market ignores. Hidden Gems recommendations are now up 33% on average, versus S&P 500 returns of just 11%. To build your investing knowledge, get two great stock picks every month, and gain full access to everything we've ever published, sample Hidden Gems for 30 days --for free. No strings attached.

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