The number of stocks in a portfolio can have a major influence on your ultimate results as an investor. Because of this, every investor must answer the question: what is a good number of stocks to own?
The short answer is that there is no right answer.
The much longer answer is that it depends on a variety of factors—it all depends on your goals, temperament, skills, and more.
This is the question we will attempt to solve in this post.
People stand on all parts of the “number of stocks to own” spectrum. Let’s take the two extremes of that first.
Then we’ll talk about a solution somewhere in the middle.
#1- The “Having Lots of Stocks” Investor
There are many investors out there who take a very hands-off approach to the market. They are generally less concerned about generating maximum return. They tend to be more concerned of keeping pace with the stock market.
This type of investor might think the stock market can’t be beaten. Or they don’t really care to try.
This investor, “the complete diversifier,” will usually buy an index fund such as one that tracks the S&P 500 and call it a day.
An investor like this will have at least 500 stocks in their portfolio, if not more. It all depends on the exact mutual funds or ETFs that they own.
A complete diversifier could take it even further by buying internationally focused ETFs. They could buy larger ETF indexes such as those that track the Russell 2000 or the NASDAQ. There could then be thousands of stocks inside this kind of a portfolio.
The more stocks that are in a portfolio, generally, the closer an investor’s return will be to the overall stock market’s (S&P 500).
But there have been exceptions.
One of the best fund managers of all-time, Peter Lynch, famously had thousands of stocks in his portfolio over his career. He absolutely trounced market averages through superior stock picking skills.
However, for the average investor, expecting these kind of results from a portfolio with thousands of stocks isn’t practical.
For one, Lynch was able to embark on this journey as a full-time job. He admitted to working 80+ hour weeks in order to maintain the grueling work ethic required to manage a portfolio of that size.
Secondly, the more stocks you own in your portfolio, the harder it becomes to beat the average stock market return.
The upside to having lots of stocks in a portfolio is that any one poorly performing stock won’t hurt performance too much. But the downside is that it you’re more likely to buy average stocks, making it very hard to beat the market.
#2 – The “Very Few” (Concentrated) Stocks Investor
So, a very diversified investor might have thousands of stocks in their portfolio. The “concentrated” investor might have a portfolio of less than 10 or even 5.
The logic is that it’s better to know what you own and make big bets on only the best opportunities.
Having a portfolio with only a few stocks has been the secret to success for many great investors like Warren Buffett and Charlie Munger. They understood the advantages of having a small portfolio.
Benefit #1 – Easier to Manage
Having a lot of stocks in a portfolio can be difficult to manage especially if you are trying to really understand the businesses of the stocks you own.
The business world is always changing, and companies need to adapt. Investors need to recognize when the fundamentals of a company they own change. When that happens, they should think about selling the investment, if it no longer meets the investor’s goals.
With only a handful of stocks, there are only so many quarterly and annual results to check up on; only so many decisions that need to be made about which stocks to sell or keep.
That kind of simplicity can go a long way towards managing a stock portfolio effectively as an average investor.
Benefit #2 – Stock Selection Actually Matters
The larger a percentage of a stock in your portfolio, the greater impact it will have on your overall performance.
If you’ve really done your homework, and are very skilled in picking the right companies, you can succeed with just one or two wisely picked stocks.
However, this potential upside also has its own downside. Just one or two poor decisions can hamper your performance for years, even if the rest of your portfolio has done pretty well.
That double edged sword makes a concentrated portfolio much more risky than a diversified one. This risk is amplified if you don’t know what you’re doing.
Risk #1 – Volatility
The stock market is a risky and volatile place on its own. When you start to get down into the individual stock level, that can magnify. Especially when the company’s prospects are uncertain.
If you have a portfolio of 500 equally weighted stocks, any one stock’s uncertainty won’t impact the total portfolio’s performance all that much. Even if a stock were to go to zero, the portfolio will still have 499 stocks. That single stock only represented a 0.2% portion and thus only represents a -0.2% loss in bankruptcy.
On the other hand, if you have a stock that makes up 20% of your portfolio and it goes bankrupt, that’s a -20% loss. Obviously that’s a much greater impact regardless of what the rest of the market is doing.
No business is immune from challenges and uncertainty, and so stock ownership means you’re likely to face volatility as an investor.
When your portfolio is concentrated, that volatility is amplified. That can lead to many negative emotions for investors, which can cascade into even worse results if it leads to panic.
Risk #2 – Slim Margin for Error
This risk goes hand-in-hand with risk #1. If your decisions make such a huge impact… make sure you know what you’re doing!
In other words, you have to actually be good at this.
Picking the right stocks means differentiating great companies from bad ones.
But it’s not just that.
You have to be able to identify when the market has priced a company’s future expectations too optimistically or pessimistically. You’ve gotta be right about that as you make a big bet.
In other words, the price you pay matters.
As I wrote recently about the pitfalls of a concentrated portfolio, most investors have several behavioral biases working against them– which can backfire tragically as they decide to own only a select few stocks.
In a nutshell, we’re more likely to be very overconfident as investors. That’s particularly scary because on Wall Street, you don’t know what you don’t know.
Also, many of us don’t have the same years of experience like Warren Buffett or Charlie Munger. We haven’t earned the right to expect great returns from having a concentrated portfolio.
So, for most investors, I recommend against having a concentrated portfolio of 10 stocks or less. I’d rather see an average investor overdiversified rather than underdiversified over the long term.
Finding Balance with Your Number of Stocks
I think the intelligent investor who is picking stocks and hoping to beat the market should start with a framework of 15-20 stocks, but with a deep understanding of what exactly that means for you.
Let’s first talk about the basics of 15-20 stocks. This framework is a very general strategy used both by fundamental and technical traders alike. A portfolio with 20 equally weighted stocks means that any one stock makes up around 5% of the portfolio.
There’s no magical reason to the 5% number, it’s just a general rule.
But it does create decent upside from any one stock, without severely damaging a portfolio’s performance in the worst case.
In other words, it leaves enough to beat the market without adding too much extra volatility or risk.
These reasons alone make it a great suggestion for most stock pickers, especially as they are first starting to build their portfolio.
Should I keep 15-20 stocks over the long term?
Where things can get complicated for stock pickers is that your portfolio won’t stay perfectly balanced over time. There will be winners and losers.
And so just because your portfolio has 15-20 stocks doesn’t mean that you’ll have a perfect 5% position size with every stock moving forward.
That’s where you’ll have some decisions to make.
Keep in mind…
Long term stock market performance comes from businesses which are able to grow their earnings over time. These companies grow by reinvesting those profits back into the business and giving some back to shareholders.
The market will always have its constantly shifting expectations. But it’s those companies that can compound capital at great rates which will have the best returns.
One of the greatest pieces of advice from Charlie Munger about buying and holding stocks was:
As investors, none of us know which companies will be the best compounders of capital into the future.
But we can make intelligent allocations into different businesses, and hope one of them proves the ability to do just that.
What also makes it interesting is that companies don’t grow in a perfect linear fashion.
You’ll often sees bursts of production and growth, which is usually accompanied by their great stock performance over time. In other words, even the best businesses will have times of lull and times of great growth.
Look no further than Microsoft, who was flat in the 2000s and then grew 17%+ annually in the 2010s!
Same company, different bursts and lulls in productivity (and results).
As investors, we can’t constantly jump ship when a company we own has a lull, because every company will come across something like that eventually.
What we need is patience. Allow companies to compound their capital over long periods. It may require putting up with subpar results for a time over its life.
At the same time, we don’t want to stay invested in businesses that are destroying value, which eventually leads to large shareholder losses.
So, we can create a rule which works well when managing our stock portfolios, and it’s to ask the question:
Going back to our Microsoft example… The company didn’t grow much in the 2000s. It stockpiled cash and investments and really didn’t have great places to invest to find that growth.
But, its Microsoft Office platforms were still strong. They were still clear leaders in their core competencies; it was just that they were at a plateau.
Contrast that to someone like Kodak.
Kodak’s big business was digital cameras, but nobody needed to buy cameras anymore because we suddenly all had cameras on our smartphones.
No matter how well Kodak reinvested any capital, their core competency was chopped off at the knees, and it would be difficult to recover from that. Their main business model was dying, and the company died shortly after.
Take that back to managing our portfolios. We need to discern the businesses with failing and obsolete models, while also having patience for companies that are temporarily struggling.
That’s why we look at the business itself, determine if it has fundamentally changed, and either sell it or hold onto it longer.
Notice how that decision did not include the number of stocks in our portfolio.
The Answer is Personal
Which is why the answer to the “good number of stocks” question is so personal.
We’ve all built our stock portfolios at different times. We’ve all been exposed to different opportunities in the stock market at different times. There are times when Wall Street expectations are or are not aligned with actual company performance (in the future).
Each decision we make on our individual stock holdings matter more than the number of stocks we have.
That’s why it’s a 15-20 stocks framework rather than a rule.
As you continue to invest over your life, and accumulate good companies and trim those that are weakening, you might see those 15-20 stocks morph into 35-40 stocks, or 75-100.
If it takes you a lifetime to get to 75-100, then you’re probably doing alright.
A portfolio like that is still much more concentrated than something like 500 or 1,000—still by as much as a factor of 10.
As you collect great businesses trading at good prices, you should eventually push through the 15-20 stocks framework if those companies truly are great.
It’s somewhere within those areas that I hope you find your balance.