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What is a good number of stocks to own?

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 Complete Diversifier

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 and more concerned of keeping pace with the stock market.

Whether that’s because they think the stock market can’t be beaten or they don’t really care to try, the complete diversifier will usually buy an index fund such as one that tracks the S&P 500 and call it a day.

So, the complete diversifier will have at least 500 stocks in their portfolio, if not more, based on the positions inside of the mutual funds or ETFs that they own.

A complete diversifier could take it even further by buying internationally focused ETFs, or buy larger ETF indexes such as those that track the Russell 2000 or the NASDAQ, in which case there could be (effectively) 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—which has classically been represented by the S&P 500.

That’s not to say that average market returns are guaranteed in an extremely diversified portfolio; there’s many ways to perform lower than the S&P 500 by including globally diversified ETFs which might not keep pace with the S&P 500 at all times.

On the other side of that, just because a portfolio has thousands of stocks doesn’t mean that average market performance or below is required.

One of the best fund managers of all-time, Peter Lynch, famously had thousands of stocks in his portfolio over his career, and 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, where 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.

Beating the Market with Lots of Stocks in Your Portfolio

The more stocks you have in your portfolio, the more winners you will have to select in order to beat the market. The stock market more or less moves together over time. In any given day you will have stocks that do better or worse than the indexes, but in general, most stocks tend to track the overall market closely. And this is due to several reasons, and in no small part due to the fact that these stocks participate in the same economy and thus achieve financial results that are unavoidably linked to that economy.

There’s even a measurement to track the similar movements (and volatility) to stocks and the overall market, and that’s called beta.

A stock with a beta of 1 is perfectly correlated with the stock market, which means it moves up and down in lock-step with the market average. This doesn’t mean that a stock like this will match the performance of the market, it just means that their prices fluctuate in a similar range. Another way to say that is that they are just as volatile.

Stocks that are more volatile than the market can greatly outperform the market in the short term, while stocks that are less volatile than the market can outperform the market over the very long term—many have.

But over time, the performance of a stock depends on its financial results and how those compare to expectations on Wall Street.

Market Expectations and Stock Market Returns

Stocks have underlying businesses attached to them. Some will grow faster than the economy, and those will tend to have higher valuations than the market. Some will grow slower, and those will tend to have lower valuations.

As the companies grow at different paces, their valuations change; some surprise the market over the long term, but in general many grow as expected (or have their valuations adjust pretty quickly to any new reality).

Since there will always be outperformers, but most stocks won’t surprise the market much, most stocks will trade close to fair value most of the time.

This means that the more stocks you add to a portfolio, the more stocks you are likely to buy which perform like expected, since by definition most stocks do just that.

So, the more stocks in your portfolio, the higher your chances of buying stocks that won’t surprise the market much, and the more stocks you’ll buy with average results.

To counterbalance those average results, you’ll need to find a greater number of outperformers, which can be difficult especially since every investor has the same number of 24 hours in a day.

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 to having lots of stocks is that it you’re more likely to buy stocks which perform as expected, making it very hard to beat the market.

#2 – The Concentrated Investor

Where a very diversified investor might have thousands of stocks in their portfolio, a concentrated investor might have a portfolio of less than 10 or even 5, with the logic that it’s better to know what you own and make big bets on only the best opportunities.

Having a concentrated portfolio with only a few stocks has been the secret to success for many great investors like Warren Buffett and Charlie Munger, and it’s because 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 changes, and companies need to adapt, and so investors need to recognize when the fundamentals of a company they are invested in change so that they can sell the investment if it no longer meets the investor’s goals.

With only a handful of stocks, there’s only so many quarterly and annual results to check up on and 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 that a stock makes up of your portfolio, the greater its individual performance will have on your overall performance.

This means that if you’re really done your homework and have a great skill towards picking the right companies, you can greatly influence your results through one or two wisely picked stocks.

However, this potential upside also has its own downside, in that one poor decision 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 especially if you don’t know what you’re doing.

Risk #1 – Volatility

The stock market is a risky and volatility place on its own. When you start to get down into the individual stock level, that can magnify especially during times of uncertainty for a company.

If you have a portfolio of 500 equally weighted stocks, any one stock going through a crisis 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, with that single stock only representing a 0.2% portion and thus only representing 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 and a much greater impact regardless of what the rest of the stock market (and economy) is doing.

No business is immune from challenges and uncertainty, and so stock ownership means you’re likely to face volatility as an investor.

You can reduce the impact of that volatility through heavy diversification, but 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, but if you’re going to rely on stocks with such heavy impact on your portfolio for performance, you’re going to need to make sure you know what you’re doing.

In other words, you have to actually be good at identifying great companies and differentiating them from bad companies.

And perhaps even more difficult—you have to be able to identify when the market has priced a company’s future expectations too optimistically or pessimistically, and be sure you’re right about that as you make a big bet.

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 overconfident as investors than the other way, and that’s particularly scary because on Wall Street you don’t know what you don’t know.

Also, many of us haven’t accumulated a similar type of experience as Warren Buffett or Charlie Munger in picking investments and 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, and would rather see an average investor overdiversified rather than underdiversified over the long term.

Finding Balance with Your Number of Stocks

If you’ve gotten this far then you’re still interested in managing a stock portfolio, and hopefully see the pitfalls in the two extreme stock portfolio management strategies.

I think the intelligent investor who is picking stocks and hoping to beat the market should have a framework of 15-20 stocks, but with a deep understanding of what exactly that means for you.

As somebody who runs a newsletter recommending a stock every month, I’m constantly hearing from investors who are at different paths of their investing journey.

Some are just starting out, and are building a portfolio for the first time.

Some might have been subscribers for months or years, and are balancing thoughts of selling or trimming rather than solely looking at just building.

Both should apply the 15-20 stocks framework differently.

Let’s first talk about the basics of 15-20 stocks. This framework is a very generalized portfolio strategy that is used both by fundamental investors and technical analysis 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 allow for any one stock to positively affect a portfolio’s results, without severely degrading the performance in the case the stock crashes or disappears.

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.

First we need to understand where long term performance comes from in the stock market.

Long term stock market performance comes from businesses which are able to grow their earnings over time by reinvesting those profits back into the business and giving some back to shareholders. The market will always have its expectations on stocks, and those will fluctuate, but over the long term—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 “The first rule of compounding: Never interrupt it unnecessarily.”

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 the patience to allow companies to compound their capital over long periods, and that requires putting up with substandard 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,

“Has anything within the business fundamentally changed?”

Going back to our Microsoft example, the company didn’t grow much in the 2000s as 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 their 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.

Taking that back to our portfolio management idea, we need to balance the propensity to disassociate from businesses with failing and obsolete models while also keeping the patience to allow companies that are lulled or plateaued to rebound into great capital compounders.

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.

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—times when Wall Street expectations were not aligned with actual company performance (in the future).

And so the decisions we make on our individual stock holdings matter more than the number of stocks we have, and that’s why it’s a 15-20 stocks framework rather than a rule.

Whether you have 5 stocks in your portfolio or 50, early indications that Kodak’s business model is permanently damaged should mean a sell. Over an investing lifetime, you’ll have time to build to 15-20 positions. It’s much harder to build back from permanent losses of capital.

In the same token, selling a stock just because it would be stock #21 of your portfolio isn’t great policy either. It could be like selling Microsoft in 2012 because the stock has been “dead money”, locking in that poor stock performance, and losing out on all of the future compounding that was in store after the company had accumulated so much cash.

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.

And if you’re collecting good businesses as they trade at great prices compared to their expectations, you should eventually push through the 15-20 stocks framework if you’re making good selections.

It’s somewhere within those areas that I hope you find your balance.

So, what’s a good number of stocks to own?

Well you don’t want too many, and you don’t want too few.

I’ve given you a framework to start, and from there it’s a naturally evolving process. By sticking with the fundamentals, like buying great businesses and letting them compound capital over time, you’re bound to find 1 or 2 which can be sources of extraordinary returns.

That’s what it’ll take to beat the market, just stick to those principles.

You can try to get there faster, you can try to take more risks, but there’s a downside to that too. That goes for all of your stocks, as much as it does to your number of positions.