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FOOL ON THE HILL
The Best Number of Stocks

When deciding how many stocks to own, there are several issues to consider, such as how much time and interest you have in keeping up with your holdings and how sure you are of the stocks you've chosen. Selena Maranjian thinks between six and 15 is a good range, although this varies for different types of investors.

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By Selena Maranjian (TMF Selena)
August 26, 2002

A few weeks ago, a post on the Rule Breaker Strategies board got me thinking. The author, Fool Community member Norationalbasis (who can actually be quite rational), wrote:

...things like this are the reason why I think it's so dangerous for investors to hold concentrated portfolios. When I see someone like Selena say that the Fool advocates investors holding six stocks, I get nervous...

He was referring to an Ask the Fool article I wrote on why large mutual funds can hurt performance. "Typically, mutual funds invest in 50 to 200 different companies, a far cry from the six to 15 stocks that Fools with the time and willingness to invest in individual stocks should shoot for," I wrote.

This raises some interesting -- and important -- questions:

  • How many different companies should you invest in (not counting companies owned via mutual funds)?

  • How few is too few, and how many is too many?

  • Should there be different ranges for different kinds of investors?

  • What about mutual funds and other holdings?

Here's what I think. (And remember -- I'm just a Fool, like you. I don't know everything about investing, but I keep reading and thinking and learning and evolving in my thinking. And learning from my mistakes.)

How many different companies should you invest in?
I'll stick with six to 15. But I'll add some caveats and explanations in the sections that follow.

How few is too few, and how many is too many?
Well, you might be able to do just fine with fewer than six and more than 15. So the range I offered is just a general guideline for most investors. A review of the reasons for the range is in order, though.

For starters, you don't want to own stock in too many companies, because you'll have trouble keeping up with them. By keeping up, I mean that, at the very least, you should read the full annual report of any company you own, including the often lengthy and sometimes dry 10-K report. If you own stock in 40 companies, that's an average of almost one report per week, over a year. (And you'll probably receive more than a dozen of these annual reports in the same month!)

To make matters worse, reviewing your holdings just once a year isn't optimal -- especially for companies in dynamic industries whose outlooks tend to change considerably within a year. Ideally, you should shoot to review your holdings at least once per quarter -- when they release their quarterly ("10-Q") reports. If you own 25 companies, that's 100 quarterly reviews per year, an average of two per week. If that seems like a snap to you, then perhaps owning more than 15 companies won't present major difficulties. But for most of us, even keeping up with a dozen can be a challenge.

Next, let's consider what's too few. Norationalbasis (remember him?) was quite right to flinch at the thought of owning just six stocks. I think it is fine in some circumstances, and I'll get to that soon. But first, a general caution.

You want to avoid owning too few companies in your portfolio. The fewer you own, the more impact on your overall portfolio each holding will have. As an extreme example, imagine that Homer has invested $10,000 in equal amounts in just two companies, while Marge has divided $10,000 equally between 10 companies. Let's see what happens to each portfolio when the stock of one company each owns doubles, and when it crashes by 50%.

One holding doubles, others remain flat:

               Portfolio's value     % gain

2 stocks       $15,000                50%
10 stocks      $11,000                10%

One holding cut in half, others remain flat:

               Portfolio's value     % loss

2 stocks       $7,500                 -25%
10 stocks      $9,500                 -5%

This illustrates a key issue: the effect of diversification vs. concentration. With a more concentrated portfolio, your successful investments pack a more powerful punch than they would if they were just a few of many holdings in a more diversified portfolio. That 50% gain above looks pretty good, right? But concentrated holdings also accentuate risk. Would you want to risk that 25% loss? The more moderate 10% to 5% proposition is a pretty good deal.

If you keep adding companies to your portfolio, at a certain point, you become overdiversified. Look at the effect one holding has on a 100-stock portfolio (with all money divided equally among holdings):

One holding doubles, others remain flat:

                Portfolio's value      % gain

100 stocks      $10,100                 1%

One holding cut in half, others remain flat:

                Portfolio's value      % loss

100 stocks      $9,950                 -0.5%

Another way to think about this is to imagine a list of all the companies you think are promising investments right now. Imagine that it's a long list of perhaps 50 attractive opportunities, ranked by attractiveness. If you've really checked out these companies and are pretty confident of your list's promise, then why would you divide your money into all 50, when you'll likely do much better dividing it between your top 10 ideas? The flip side, though, is important: If you haven't done much homework on these companies; if you're not too sure of your list; if you're not yet a savvy investor, then the more you concentrate the portfolio, the more risk you're taking. It becomes more of a crapshoot.

Should there be different ranges for different kinds of investors?
Yes, indeed. This is a good point to cover, because investing matters are rarely one-size-fits-all. Here are just a few kinds of investors, and some thoughts for each:

  • For sophisticated investors who know what they're doing, a concentrated portfolio with fairly few holdings can be effective.

  • If you're a beginner, it's OK to start by putting a small portion of your investment funds into one company, and then another, and another, as you keep learning. So you'd start with a very small portfolio and slowly grow it, taking care not to end up with too many holdings. New investors should probably not plunk all they own into the stock market at once -- first take time to learn more, to become completely comfortable with what you're doing. Investing via Drips is a great way to ease into an investing mindset and lifestyle, and you can start with one company and add more. You also might want to take our Choosing Stocks With The Motley Fool online seminar, to help you learn how to evaluate companies and determine which are stronger and more promising than others.

  • If you're really new to investing, then consider doing nothing until you learn more. (Perhaps start with our 13 Steps to Investing Foolishly.)

  • If you know little about investing and don't want to learn much because you're sure it wouldn't interest you, then consider investing in index funds -- perhaps dollar cost averaging in, over time.

  • One attractive possibility for a variety of investors is using an "index-plus-a-few" approach, where you combine an index fund with a handful of stocks. My colleague Matt Richey will explain this approach tomorrow, in Fool on the Hill. So return to learn all about it.

What about mutual funds and other holdings?
This is another key point. If 90% of your invested money is in bonds and mutual funds, and you're thinking about investing the remaining 10% in the stock of just three companies, that's not necessarily concentrated. It's not the same as taking everything you own and dividing it between three companies.

It's always important to evaluate your whole portfolio. Don't think of your net worth as lots of different buckets. Think of the buckets as combined into one tub. Then ask yourself whether you're spread out over too few or too many holdings, whether you're invested in too many risky, high-flyer companies or sleepy non-performers, or whether you're investing too aggressively or conservatively. Look at the big picture.

Now... what do you think about this topic? If you'd like to rebut or expand upon anything I've said or have additional points to make, please do so on our Fool on the Hill discussion board. (Perhaps just drop in to see what others are saying.) Also, if you think any friends would be interested in this article, e-mail it to them! Just click the handy link below, and we'll do most of the work for you.

Finally, check out some other Fool articles. This handy page lists this week's content for you.

[Enroll in Choosing Stocks With The Motley Fool and start building your long-term wealth now!]

At Selena Maranjian's potluck parties, guests have pizza delivered. To see Selena's complete stock holdings, view her profile. The Motley Fool is Fools writing for Fools



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