In today's #AskDrWealth series, I am going to address the most popular question from our readers and students.
"How Many Stocks Should I have In My Portfolio?"
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Which Is Better? - Diversified portfolio or Concentrated Portfolio
Let's imagine that there's Investor A and Investor B, with different types of portfolio:
- Investor A has a portfolio of 5 stocks (concentrated)
- Investor B has a portfolio of 30 stocks (diversified)
Let's assume that both portfolios are equally weighted.
This means for A, each stock represents about 20% of the portfolio while for B, each stock represents about 3%.
- Investor A: 100% / 5 stocks = 20% per stock
- Investor B: 100% / 30 stocks = 3% per stock
At a quick glance, inexperienced investors would think that having 5 stocks is better than having 30, simply because...
"Having 5 stocks means you would have less stocks to monitor and would require less effort to do so."
This is where many newbie investors get into trouble and here's why:
The Hidden Danger of a Concentrated Portfolio
Imagine your portfolio is similar to Investor A's. One day, one of your stocks goes bad and its price suddenly tanks to zero.
In a blink of an eye, you have just lost 20% of your portfolio!
In contrast, imagine that your portfolio is similar to B's. If you had invested in the same exact stock and it goes to zero, you have only lost 3%.
This means that A is actually exposed to more risk per stock than B. A concentrated portfolio can be very unforgiving in this sense.
Hence, you will have to do a lot more work to ensure that your stock picks are highly likely to be correct or else you are going to suffer major losses.
Conclusion: for a concentrated portfolio, one has to actually do more work than those with a diversified portfolio.
With that said...
although a concentrated portfolio has greater risk and requires more work, it might be a feasible option for a certain group of investors.
As you can see from the time series above, the flip side is true for the concentrated portfolio too!
Who Should Be Deploying A Concentrated Portfolio?
In the case of a concentrated portfolio (blue lines in Image 1), you can see that the growth can be very fast on the upside. You can also see that the downside, on the other hand, can be equally fast.
Comparatively, a diversified portfolio (green lines) would have a gentler curve meaning you don't expect the portfolio returns to be as good as a concentrated portfolio, if you get the stocks correct.
Conclusion: If you are an experienced investor, it makes sense to do a concentrated portfolio. However, if you are still a beginner, then you should be doing a diversified portfolio.
How Many Stocks Should I Have In My Portfolio?
You're probably wondering, so...how many stocks should a portfolio have to be 'diversified'?
Research has found that the golden number is actually 15.
If you have 15 stocks across different sectors and industries, you would have reduced your unsystematic risk(aka stock picking risk) by 90%.
The study had also shown that owning more than 15 stocks doesn't reduce your risk much further.
So if you are starting out and you want to buy stocks, you should aim to own minimally 15 stocks in your portfolio.
Leave a comment below and let me know if you have any investing questions! I might just do a video for you 🙂