What is the ideal number of stocks to have in a portfolio?

By Investopedia Staff AAA
A:

First off, there is no single correct answer to this question - it will depend on a number of factors such as your country of residence and investment, your investment time horizon and your propensity for reading market news and keeping up-to-date on your holdings.

Investors diversify their capital into many different investment vehicles for the primary reason of minimizing their risk exposure. Specifically, diversification allows investors to reduce their exposure to what is referred to as unsystematic risk, which can be said to be the risk associated with a particular company or industry. Investors are unable to diversify away systematic risk, such as the risk of an economic recession dragging down the entire stock market, but 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 levels, while still maintaining the same expected return level a portfolio with excess 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 stock, particularly those of various sectors or industries, is much less risky than a portfolio of two. Of course, 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 reasonably certain range.

For investors in the U.S., where stocks move around on their own more (are less correlated to the overall market) than elsewhere, the number is about 20 to 30 stocks. Predominant research in the area was conducted prior to the revolution of online investing (when commissions and transaction costs were much higher), and most research papers put the number in the 20-30 range. More recent research suggests that investors taking advantage of the low transaction costs afforded by online brokers can best optimize their portfolios by holding closer to 50 stocks, but again there is no consensus.

Keep in mind that these assertions are based on past, historical data of the overall stock market, and therefore does not guarantee that the market will exhibit the exact same characteristics during the next 20 years as it did in the past 20. As a general rule of thumb, however, most investors (retail and professional) hold 15-20 stocks at the very least in their portfolios. If you are intimidated by the idea of having to research, select and maintain awareness of about 20 or more stocks, you may wish to consider using index funds or ETFs to provide quick and easy diversification across different sectors and market cap groups, as these investment vehicles effectively let you purchase a basket of stocks with one transaction.

(For further reading, see The Importance Of Diversification and Diversification Beyond Equities.)

RELATED FAQS

  1. Are small cap companies less safe investments than large cap companies?

    Compare the safety of investing in small- and large-cap companies. Find out how each performs in different situations and ...
  2. Which United States Presidents have run the largest budget deficits?

    Take a look at which presidents were in office for the largest budget deficits in U.S. history and how the responsibility ...
  3. How is correlation used differently in finance and economics?

    Take a look at the similarities and differences between how statistical correlation is applied in economics as opposed to ...
  4. How is correlation used to measure volatility?

    See how the correlation between an asset and its benchmark index can be used as a proxy to determine the relative volatility ...
RELATED TERMS
  1. Next Generation Fixed Income (NGFI) Manager

    A Next Generation Fixed Income (NGFI) manager is a fixed income ...
  2. Next Generation Fixed Income (NGFI)

    Next generation fixed income is an innovative approach to investing ...
  3. Back-To-Back Deductible

    An insurance policy deductible that is the same as the coverage ...
  4. Blended Finite Risk

    Insurance that provides coverage against multiple types of risks ...
  5. Smart Beta

    Investment strategies that emphasize the use of alternative weighting ...
  6. Complete Retention

    A risk management technique in which a company facing risks decides ...

You May Also Like

Related Articles
  1. Stock Analysis

    Is Prospect Capital Exposed To Elevated ...

  2. Mutual Funds & ETFs

    The Impact of the Janus Market Timing ...

  3. Mutual Funds & ETFs

    These 4 Precious Metals ETFs Help Combat ...

  4. Stock Analysis

    Dividend-Paying ETFs: Here Are 5 Worth ...

  5. Mutual Funds & ETFs

    Preferred Stock ETFs: Are They Right ...

Trading Center