There are thousands of stocks you can invest in right now in the U.S., plus thousands of stocks abroad, too. So what's the right number of stocks to own in your portfolio? Well, there's no one-size-fits-all answer, but here are three sound responses to that question.
1. Consider owning 15 or more
Brian Feroldi: My rule of thumb is that you need to own at least 15 stocks to be considered diversified, but that advice presupposes that you have the time and inclination to keep close tabs on all of the companies whose stock you own.
That's likely to require more work than most individual investors can handle on their own, which creates a bit of a conundrum. On the one hand, investors should buy a broad basket of different stocks to ensure they are diversified. On the other hand, each new company that is added only increases the amount of time that needs to be spent on research. This reality can cause some individual investors to keep their portfolios far more concentrated than they should be, which is asking for a world of pain if just one of the stocks turns out to be a bad pick.
So what's the happy medium here? For those investors who are time-strapped, I'd suggest that they keep the bulk of their funds in simple index funds and then add individual stocks as a complement to the portfolio. Using this strategy will allow you to stay diversified while keeping your required time commitment to a manageable level.
As a quick example, if you believe that you have enough time to follow five companies closely, then it might make sense to buy a 5% position in each. Then, invest the remaining 75% in broad-based index funds. Doing so would allow you to sleep well at night and protect you from a busted stock, even though you only own a handful of individual companies.
2. Goldilocks says 20 stocks can be just about right
Chuck Saletta: Diversification used in the context of a strong overall investing strategy provides your portfolio solid protection against the potential failure of one of the companies within it. If you don't diversify and instead find yourself significantly over weighted in a stock as its business falls apart, your money can quickly vanish. On the flip side, over-diversifying puts you at risk of making bad investments just for the sake of diversification, and that can hurt your overall returns instead of protecting your portfolio.
So clearly, some balance between protecting your portfolio and enabling it to deliver decent potential returns is important, and that's where a portfolio of around 20 stocks can find that sweet spot. According to a study reported in Investment Analysis & Portfolio Management: "The major benefits of diversification were achieved rather quickly. Specifically, about 90% of the maximum benefit of diversification was derived from portfolios of 12 to 18 stocks."
With around 20 stocks spread across industries, you can receive the vast majority of the potential benefits available from diversification while still being able to focus your efforts on your top investing ideas. Over the long run, the stock market has provided total returns of about 10% annualized. With 20 equally weighted investments, the complete and total loss of any one company in your portfolio would only knock your portfolio down 5% -- or about a half-year's worth of that historical return rate.
In my mind, that's a reasonable "Goldilocks" point between the risks of investing in individual stocks and the risks of over-diversifying into bad investments just for the sake of diversification.
3. Sometimes the right answer is just one
Selena Maranjian: For many people, the right number of stocks to own can be as low as... one. That's because many of us just don't have what it takes to maintain a portfolio full of a bunch of different companies' stocks. You might have the interest in stock-picking, but not the stock-picking skills. You might have the skills, but not the time to research companies and then keep up with the ones you buy.
Fortunately, you're not out of luck. Considering that most stock mutual funds underperform simple index funds over long periods, it makes a lot of sense to just stick with an inexpensive, broad-market index fund. Here's how bad the situation is: According to the folks at Standard & Poor's, as of the end of 2015, fully 83% of all domestic stock mutual funds underperformed the S&P 1500 Composite Index over the past 10 years. And 82% of large-cap stock funds underperformed the S&P 500.
Even superinvestor Warren Buffett has recommended index funds for "non-professional" investors. In his 2013 letter to shareholders, he noted that "the goal of the non-professional should not be to pick winners ... but should rather be to own a cross-section of businesses that in aggregate are bound to do well. A low-cost S&P 500 index fund will achieve this goal." Indeed, he says that in his will, he offers these instructions for the money left for his wife: "Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard's.)"
So consider just keeping things simple by sticking with index funds -- or their stock-like cousins, exchange-traded funds (ETFs). Three to consider are the SPDR S&P 500 ETF (NYSEMKT:SPY), Vanguard Total Stock Market ETF (NYSEMKT:VTI), and Vanguard Total World Stock ETF (NYSEMKT:VT). They distribute your assets across 80% of the U.S. market, the entire U.S. market, or just about all of the world's stock market, respectively. Just one of these will have you immediately invested and diversified, with little further oversight needed.
Brian Feroldi has no position in any stocks mentioned. Chuck Saletta has no position in any stocks mentioned. Selena Maranjian has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.