David Gardner and The Motley Fool recommend that investors build up a diverse portfolio -- say, 20 stocks at least -- so that no single company contributes too much risk to your net worth. But is it possible to diversify so far that you can't really beat the market anymore, because you're essentially averaging down to the mean? Or will Foolish investing principles prevent that from becoming a problem?
In this segment from the Rule Breaker Investing podcast, David gives his view.
A full transcript follows the video.
This video was recorded on Dec. 27, 2017.
David Gardner: Mailbag Item No. 2: This one comes from Dave Rossman. It's a longer note, so I'm going to truncate it some, Dave, but thank you for writing in. Dave writes, "As a huge fan of The Motley Fool, I'm always looking to learn how to better construct and manage my portfolio that I've spent the last five years building. While I started with subscriptions to Stock Advisor and Rule Breakers, I've since upgraded to Market Pass and more recently to Motley Fool Premier Pass.
In my progression through these different services, and my interest in upcoming trends like AI, crypto society, etc., I keep adding more stocks to my portfolio to 'reflect my best vision for the future.'" I appreciate that allusion to one of my favorite lines. Thanks, Dave! "At this point," you go on, "I have 50-plus stocks in my portfolio, which widely range in market cap and industry. So while listening to different Motley Fool podcasts, from time to time the topic comes up about how many stocks I should have in my portfolio. While answers do vary to this question, it does seem that The Motley Fool prefers 15 to 20, maybe even up to 30 stocks.
"I truly understand the reason behind this direction. The core or target audience, I would assume, is more beginning investors, and by putting out a larger recommendation, you could overwhelm an early investor. I get it completely. I've been there," Dave says, "but in response to this question I've heard many times on podcasts that once you get more than 15 to 20 stocks in your portfolio, it could perform closer to the index, and I disagree with this argument."
Dave goes on, and he cites a couple of reasons, but basically he talks about how if you take the whole market -- let's say 5,000 or so stocks -- and you just strip out all the bad ones, you'd still have hundreds and hundreds left, but mathematically you would easily beat the market, since the total market return is just averaging all of those different returns. Even if you're not particularly good at finding the good ones -- you're just good at avoiding the bad ones, David would point out -- you can do pretty well as an investor and you might have hundreds of stocks.
Dave concludes his note by saying, "With 50-plus stocks in my portfolio, all Motley Fool recommendations, proud to say that year to date 2017, while the S&P index is up 19.52%, my portfolio is up 26.59%." Again, that's with 50-plus stocks. "That is the sole reason why I invest," Dave says, "to beat the index."
Well, that's very Foolish of you, Dave. You and I share that same urge, to beat the market indices. After all, if we're not going to be beating the indices, then we could just buy and own the indices. But I, as a fellow 50-plus stock guy, am not somebody who believes that you should just never have more than, let's say, 15 or 20 stocks, or you'll start to approximate an index fund. Simple math will say with every additional stock that you add, that chances are you will regress to the mean of the market, but I think you can have a few hundred stocks.
We have members who have bought literally every recommendation we've ever made in Motley Fool Stock Advisor, and that's going back to March of 2002. They're way ahead of the market, and frankly, it's easy to see why. We put the numbers right there in Motley Fool Stock Advisor. If you have bought every one of my recommendations over the last 15 years, you've about quadrupled the market's return.
I don't think that there's any magic number or that you need to limit yourself to a certain number of stocks. I do think it comes down, largely, to how much energy, time, and interest you have, and I think I'm speaking to somebody who has quite a lot. When you're quoting me market averages and returns to the second decimal, saying the S&P's up 19.52%, that suggests to me that you're somebody who puts a lot of time and effort here, and look, you're getting rewarded for it.
So great job, one Dave to another. Well played! And I like your perspective.