For decades, traditional wisdom dictated that a well-diversified portfolio should hold around 30 individual stocks. This magic number supposedly offered a balanced risk and reward, minimizing exposure to any single company’s performance while capturing the benefits of a broad market.
However, the digital age has ushered in a new era of investing that prompts a reevaluation of this traditional recommendation. But how many are the ideal number of stocks to have in a portfolio?
You must be wondering about that, and one should if they want to diversify their portfolio. Let’s just explore more about it in detail!
The Rise and Fall of the “30-Stock Portfolio”
The “30-stock portfolio” rule of thumb gained popularity in the mid-20th century. Modern Portfolio Theory (MPT), a cornerstone of traditional finance, emphasizes diversification as a key risk management strategy. The theory suggests that holding a sufficient number of uncorrelated assets could reduce portfolio volatility without sacrificing returns.
Thirty stocks were considered enough to achieve this diversification, which offers exposure to various sectors and mitigates the impact of any single company’s downfall. Back then, access to information and investment options was limited. Retail investors primarily relied on stockbrokers and mutual funds, often resulting in portfolios naturally gravitating towards this range.
However, the digital age has significantly altered the investment landscape. Here’s how-
- Increased Market Access
Retail investors now have access to a wider range of assets, such as foreign equities, exchange-traded funds (ETFs), and fractional shares, thanks to online platforms and commission-free trading that have democratized investing.
- Data Explosion
Investors now have access to comprehensive business financials, real-time market data, and advanced analytical tools. This enables the making of better-informed investment choices and maybe more concentrated portfolios.
- Rise of Low-cost ETFs
The rise of exchange-traded funds (ETFs) that follow large market segments or niche investing methods has revolutionized the portfolio construction process for investors. Instantaneous diversification over hundreds or even thousands of underlying stocks can be obtained with a single ETF.
These factors challenge the “one-size-fits-all” approach of the 30-stock portfolio.
Why Does the Ideal Number Might Be Lower?
- Lower Costs
Transaction fees can significantly impact returns, especially for smaller investors. Traditionally, buying individual stocks came with a per-trade expense. However, the rise of commission-free trading platforms and fractional shares has changed the game.
With these tools, investors can build a smaller portfolio with strategically chosen assets without worrying about high transaction fees eating into their returns.
- Increased Management Time
It takes time to thoroughly research and keep an eye on a lot of stocks. It necessitates monitoring market trends for every holding, examining financial accounts, and staying up to date on corporate news.
Investors are able to dedicate more time and attention to each stock when their portfolio is smaller. Deeper due diligence may result from this, which could help investors make more wise choices.
- Potential for Higher Returns
Diversification is prioritized in the standard 30-stock portfolio to reduce risk. Even though diversification is crucial, there may be more opportunity for higher returns in a smaller portfolio consisting of properly chosen, high-conviction stocks.
Businesses with significant long-term growth potential and attractive prospects can attract the attention of investors.
A 2017 study by AQR Capital Management found that a portfolio containing just 6-8 carefully selected stocks could outperform the market over the long term. However, this strategy requires a high degree of research expertise and risk tolerance as a single underperforming stock can significantly impact returns.
Arguments for Maintaining a Larger Portfolio
Despite the digital revolution, there are still advantages to a larger portfolio with more than 10 stocks:
- Reduced Risk
The “basket of eggs” approach is a traditional fundamental idea in portfolio diversification. You reduce the impact of any single company’s failure by distributing your investments across several businesses and industries. Those who are risk averse should pay special attention to this.
- Reduced Correlation
The ideal portfolio aims for holdings with low correlation, meaning their prices don’t move in tandem. A broader portfolio increases the chances of including assets that perform well during different market conditions.
- Automatic Rebalancing
ETFs offer an advantage here. With hundreds of underlying assets, owning a diversified exchange-traded fund (ETF) offers immediate diversification. Many platforms offer automatic rebalancing features that ensure your portfolio stays within your desired asset allocation over time.
The Ideal Number- It Depends
There’s no magic bullet answer to the ideal number of stocks for a portfolio. It depends on several factors, including:
- Investment Goals
Are you prioritizing long-term growth, income generation, or capital preservation? Growth-oriented investors might consider a smaller portfolio with high-conviction stocks, while income investors might benefit from a larger, dividend-paying stock selection.
- Risk Tolerance
How comfortable are you with market volatility? Risk-averse investors may favor a larger portfolio with broader diversification to mitigate risk.
- Investment Time Horizon
Long-term investment may benefit from a smaller, actively managed portfolio with strong growth potential. Investors with shorter time horizons may want a more conservative, diversified strategy with a higher number of holdings.
- Investment Knowledge and Experience
Do you have the time and expertise to research and manage a concentrated portfolio? If not, a larger, passively managed portfolio through ETFs might be a better fit.
Here’s a breakdown of potential portfolio sizes and their corresponding considerations-
Smaller Portfolios (5-10 stocks)
- Pros- With a small investment, you can experiment without taking on more risk than you can reasonably anticipate and handle promptly. Consider the opportunity cost of your little investments: you might use the money you have set aside for a new investment and allocate it to a well-established area of your portfolio. This even lowers costs, increases management time, and offers the potential for higher returns.
- Cons- If you invest small amounts of money, you will lose less if it doesn’t work out, but you will also have fewer opportunities to make rewards. Naturally, this could be advantageous if you’re risk-averse or prefer a cautious approach to investing.
Medium Portfolios (10-20 Stocks)
- Pros- It balances risk and reward and allows for some active management and sector allocation.
- Cons- It still needs research and might not provide total diversification. It does have limited customization and you might not be able to get more control over it.
Larger Portfolio (20+ Stocks)
- Pros- Investing in larger portfolios will lower risk through diversification, which will be suitable for passive investors’ automatic rebalancing potential with ETFs.
- Cons- In comparison to smaller, more concentrated portfolios, individual equities may have higher management expenses and maybe worse returns.
Finding the Right Balance
Here are some tips for determining the ideal number of stocks for your portfolio:
- You need to understand your comfort level with risk & tailor your portfolio size accordingly.
- Are you aiming for growth, income, or capital preservation? If you are, you must choose a portfolio structure that aligns with your objectives.
- Longer time horizons allow for a more concentrated and potentially higher-risk approach.
- Tools for online portfolio analysis can assist in determining your degree of diversification and pointing out any possible gaps. A financial advisor can help design a personalized investing strategy that considers your particular circumstances.
Conclusion
Ultimately, the “ideal” number of stocks is subjective and depends on your unique financial situation and goals. The digital age offers a wider range of investment options and tools, allowing for more tailored portfolios.
You may create a portfolio that balances risk and return in the ever-changing world of investing by carefully evaluating your needs and taking advantage of technological advancements.
Peter Williams, a financial writer with over five years of experience, specializes in covering stock market movements, bond markets, commodities, and macroeconomic trends.
