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. Under what circumstances is short selling advisable?

    Find out when short selling a stock is profitable and what an investor should keep in mind before deciding to pursue a short ...
  2. What is the average price-to-book ratio in the oil & gas drilling sector?

    Calculating the price to book ratio for oil and gas drilling companies can provide insight for investors interested in understanding ...
  3. What is the downside of investing in the utility sector?

    Learn about the pros and cons of investing in the utility sector, and determine whether the steady dividend income possibility ...
  4. Why is buying a utility stock known as defensive move?

    Utility stocks are known as defensive stocks for investors due to the fact that consumer demand will remain high even when ...
RELATED TERMS
  1. Complete Retention

    A risk management technique in which a company facing risks decides ...
  2. Alternative Risk Transfer (ART) Market

    The portion of the insurance market that allows companies to ...
  3. Investment Income Ratio

    The ratio of an insurance company’s net investment income to ...
  4. Adjustable Feature

    Contract language that allows adjustments to be made to the premium ...
  5. Development To Policyholder Surplus

    The ratio of an insurer’s loss reserve development to its policyholders’ ...
  6. Overall Liquidity Ratio

    A measurement of a company’s capacity to pay for its liabilities ...

You May Also Like

Related Articles
  1. Stock Analysis

    Time to Look at PIMCO's Total Return ...

  2. Mutual Funds & ETFs

    These Oil ETFs Offer Cheap, Easy Access

  3. Mutual Funds & ETFs

    Why Monthly Dividend ETFs are Good for ...

  4. Professionals

    Why Investors Need to Rebalance Their ...

  5. Trading Strategies

    5 Ways To Adapt To Tough Markets

Trading Center