What is the ideal number of stocks to have in a portfolio?
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.
Most portfolios own between hundreds or thousands of stocks because of the use of mutual funds, index funds, and various managed stock accounts. Diversification can be accomplished with a little as 20-30 stocks, without too much exposure to any one sector or company. As an alternative to buying an index, you could purchase 2-3 different high quality stocks every month and after a few years you would develop a robust portfolio. The key being quality stocks, because this strategy only works when you commit to it and do not make short term selling decisions based on fear.
There really isn't an "ideal" number of stocks to have in a portfolio, but there are a few guidelines that make portfolio management work to your advantage.
First, in order to be considered diversified, an Investment Company must limit its exposure to any one security in a portfolio to 5%. A portfolio that had 20 stocks all representing 5% would meet the definition. If the portfolio strategy seeks to over-weight securities in sectors of the economy, or of a particular type, while under-weighting other stocks that are believed to be somewhat less attractive or more risky, half and quarter positions could add to the total number.
Standard & Poor's (S&P) divides the economy into 11 Sectors and Industries: Consumer Discretionary, Consumer Staples, Energy, Financials, Health Care, Information Technology, Materials, Real Estate, Telecommunications Services and Utilities. A portfolio that wanted to always have some exposure to all of these and remain diversified would need perhaps as many as 40 positions to avoid reliance on one or two stocks in each sector.
Bear in mind that the richest man in the world, Bill Gates, has only one stock in his portfolio.
Good question. This depends on a number of elements; the size of your account, your investment objectives, your investment time-frame, your risk tolerance and your investment strategy. Most investors who are risk averse should likely stick with ETFs and funds, but if you have the risk appetite and the time to do research, stocks can work well. If you are investing $10,000, maybe 3 stocks. If you are investing up to $50,000, 10 stocks. And up to $100,000, 20 stocks.
Depending on the liquidity of the stocks you are trading, I would stick with no more than 20 because once you get beyond that, it may be difficult to track and update your holdings.
Thanks for asking this question on Investopedia!
Are you committed to investing in individual stocks? Will you be managing the portfolio yourself? If you answer "yes" to both I think that you want to do extensive research and reading in order to find a strategy that you can embrace, such as dividend investing. Then, you will want to accumulate the number of stocks that you can comfortably monitor over time. So, depending on how much time and interest that you have, that might be 5 stocks. Or, it might be 20 on the high side. You will find that the major discount brokers have great tools and education to assist you.
Have fun and enjoy the journey! Good luck!