What Is the Ideal Number of Stocks to Have in a Portfolio?

While it might seem that many sources have an opinion about the right number of stocks to own in a portfolio, there is no single correct answer to this question.

The correct number of stocks to hold in your portfolio depends on many individual factors, from your country of residence to your investment time horizon, the market conditions, and your propensity for keeping up to date on the financial news.

Key Takeaways

• Diversification is critical to achieving long-term returns while limiting risk.
• The precise number of investments in a diversified portfolio depends on the individual.
• Redundancy is usually inefficient. That is, having many stocks that pay high dividends or many growth stocks increases your costs while doing little to reduce risk.

Understanding the Ideal Number of Stocks to Own

Investors diversify primarily to minimize their exposure to risk. Diversification reduces the investor’s exposure to unsystematic risk, which can be defined as the risk associated with a particular company or industry.

It is not possible to eliminate all risk from a portfolio. There’s always the risk that an economic recession will drag down the entire stock market. However, academic research in the area of modern portfolio theory has shown that a well-diversified equity portfolio can effectively reduce unsystematic risk to near zero while maintaining the same expected return level a portfolio with excessive risk would have.

In other words, while investors must accept greater systematic risk for potentially higher returns (known as the risk-return tradeoff), they generally do not enjoy increased return potential for bearing unsystematic risk.

The more equities you hold in your portfolio, the lower your unsystematic risk exposure. A portfolio of 10 or more stocks, particularly across various sectors or industries, is much less risky than a portfolio of only two stocks.

Consider Funds

The transaction costs of holding more stocks can add up, so it is generally optimal to hold the minimum number of stocks necessary to effectively remove their unsystematic risk exposure.

What is this number? There is no consensus answer, but there is a reasonable range.

Important

A well-diversified equity portfolio can effectively reduce unsystematic risk to near-zero levels without affecting the investor’s long-term return.

More recent research suggests that investors taking advantage of the low transaction costs afforded by online brokers can hold as many stocks as they want. However, there is a time-cost fallacy and most investors find their portfolios perform as well if not better when they use an online broker and buy mostly exchange-traded funds (ETFs).

If you are intimidated by the idea of having to research, select, and track many individual stocks, you may wish to consider using index mutual funds or ETFs to provide quick and easy diversification across different sectors and market cap groups. These funds effectively let you purchase a basket of stocks with one transaction.

How Many Stocks Should You Own for a Diversified Portfolio?

There is no magic number, but it is generally agreed upon that investors should diversify by choosing stocks in multiple sectors while keeping a healthy percentage of their money in fixed-income instruments. The bonds or other fixed-income investments will serve as a hedge against stock market downturns.

This usually amounts to at least 10 stocks. But remember: many mutual funds and ETFs represent ownership in a broad selection of stocks such as the S&P 500 Index or the Russell 2000 Index.

How Many Stocks and Bonds Should Be in a Portfolio?

If you take an ultra-aggressive approach, you could allocate 100% of your portfolio to stocks. A moderately aggressive strategy would contain 80% stocks to 20% cash and bonds. For moderate growth, keep 60% in stocks and 40% in cash and bonds.

A conservative approach calls for investing no more than 50% in stocks.

A good rule of thumb is to scale back the percentage of stocks in your portfolio and increase the percentage of high-quality bonds as you age.

This protects the investor from ill-timed market downturns. A 30-year-old investor might hold 70% in stocks and 30% in bonds, having plenty of time to recover from market downturns. A 60-year-old would have 40% in stocks and 60% in bonds.

How Many Stocks Should I Own With $10,000?

Many individual investors are choosing to diversify their investments using ETFs. This gives them access to many more companies than they would be able to buy into if they had to purchase individual shares.

Ten thousand dollars invested in several ETFs could result in exposure to thousands of stocks.

The Bottom Line

You don’t need a huge number of stocks and bonds to create a balanced portfolio. You just need to make diverse choices, balancing risk and safety. That is your best strategy to achieving your financial goals.

If you want to achieve diversity without the hands-on supervision and potential costs that come with owning individual stocks and bonds, consider mutual funds or exchange-traded funds. A wise selection of these will give you broader exposure than almost any individual investor could otherwise achieve.

Read the original article on Investopedia.