One of the most common questions that new investors have is how many stocks should they own in their portfolios? While there is no "right" answer to this question, there are a handful of guidelines that can be used to help you find your own ideal number. Below are a few of our Foolish contributors' thoughts on the matter.
The Magic 8 Ball says...
Todd Campbell: Let's face it. If there was a magic number of stocks that guaranteed limited risk and maximum reward through thick and thin, then researchers would agree on what that number is, and it would already be widely known to investors. Instead, researchers have offered up numbers over the years that range from as few as 10 stocks to as many as 120 stocks.
Personally, I think a dozen is probably the fewest number of stocks I'd own to insulate myself against the risk of one bad egg spoiling the bunch. That thinking is backed up by investing legend Benjamin Graham, who was Warren Buffett's mentor and the author of The Intelligent Investor. In his book, Graham suggests that the sweet spot for investors is somewhere between 10 and 30 stocks.
Intuitively, that makes sense. Tracking 120 stocks would be a full-time job best left to portfolio managers with a team of analysts, while a handful of names isn't likely to spread your risk around to enough sectors. After all, there are 10 sectors in the S&P 500.
Therefore, while there may be no specific number of stocks that you should own, somewhere in Graham's ballpark is probably a good bet.
Only as many as you can keep track of
Brian Feroldi: Investors who want to own individual stocks must be willing to do homework on the companies that they own in order to ensure that their theses are still on track. Thus, the more individual stocks that they own, the more homework they must be willing to take on, which can be a tall task for shareholders with limited time on their hands.
For that reason, I believe that investors should only own the number of stocks that they feel they can actively manage, even if that means they only own one or two stocks. Of course, holding so few investments will not allow for proper diversification.
The easiest fix is to keep the bulk of their capital invested in index funds, and sprinkle in a few individuals stocks on top. Following this strategy will allow investors to stay diversified, and keep their homework requirements to a manageable level.
If you're looking for an index fund to get you started, I suggest you look at the Vanguard Total Stock Market ETF (NYSEMKT:VTI). This fund holds more than 3,000 stocks of all different sizes, which provides instant diversification. It also has a dirt-cheap expense ratio of 0.05% and a turnover rate of 3.5%, which makes it highly tax efficient. That makes it a great starting point in which to keep the bulk of your wealth, and then layer in individual stocks.
The right number for you might be zero.
Selena Maranjian: For many people, the right number of stocks to own in their portfolios is zero. That's because not everyone is ready and equipped to be an investor in individual stocks. Here are some questions you might ask yourself to see how ready you are:
- Do I understand that the stock market and individual stocks can be volatile, and that there are likely to be occasional downturns?
- Will I invest with discipline and patience, or will I be led by my emotions, grabbing possibly overpriced stocks when the market is surging, and dumping potentially great long-term holdings in a panic when the market dips?
- Do I have a solid understanding of exactly how the companies I want to invest in make their money? (It's not enough to know a company is a bookstore, for example. You need to know if it sells its wares in brick-and-mortar buildings, online, door-to-door, or in some other way.)
- Do I have the time to follow the companies I'll invest in, reading their quarterly and annual reports, and ideally finding and reading articles about them and their competitors? If I have the time, do I have sufficient interest in investing so that I will spend the time on it?
- Do I know my way around financial statements, so that I can assess various companies' growth rates, debt levels, profit margins, returns on assets and equity, inventory turnover, and so on -- looking for trends and comparing peer companies?
- Am I investing in stocks for the long haul, such as five or 10 or more years? (Money you'll need soon should be in less volatile places.)
- Am I willing to keep learning more about investing, so that I can make more smart moves, avoid more dumb ones, so that my portfolio might deliver better results?
There's no shame in finding yourself not suited for investing in individual stocks right now. Most people are rather busy in their lives, without much time for investing, and even without much interest in learning about it. These folks can do very well just sticking with broad-market index funds such as ones based on the S&P 500. They actually outperform most stock mutual funds over long periods.
Brian Feroldi 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.