Does a 10-stock portfolio offer the perfect balance between risk and reward?

Should investors have only ten stocks in their portfolios?

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Diversification is widely viewed as a fundamental part of investing. The logic is relatively straightforward. Any company can experience difficult trading conditions which may lead to a falling share price. Holding more shares means the impact of such a disappointment on an investor’s overall returns will be lower if he/she holds a larger range of shares.

However, not all investors are pro-diversification. In fact, Warren Buffett is apparently against it for investors who are able to spend time researching stocks. While tracker funds can have appeal in his opinion, diversifying can be a mistake for more experienced investors since it can dilute overall returns.

Risk vs reward

Of course, Warren Buffett has been hugely successful in his investing career. His ability to unearth good value stocks which can deliver high returns over a sustained period of time has been exceptional. Therefore, if an investor is able to replicate this ability, albeit to a potentially lesser extent than Buffett, then buying fewer stocks for a portfolio could make sense. It could allow an investor to generate returns which are higher than for the wider index.

Clearly, though, fewer stocks means that the risk of loss is higher. Buffett does not have a perfect track record and has experienced major losses at times. For example, he sold Tesco at a loss following its profit warning in the aftermath of the financial crisis, while his foray into the oil and gas industry via ConocoPhillips was less successful than he had hoped. On both occasions, the opportunity cost for his wider portfolio was significant, which would not have been the case had he sought greater diversity.

Ten stocks

Holding only ten stocks in a portfolio may also have an advantage in terms of efficiency. Most investors are time-poor individuals and this means that they may lack the ability to conduct in-depth research about a range of stocks. Therefore, holding a smaller number of companies could allow them to build more detailed knowledge in specific stocks or sectors. This may aid their ability to generate high returns and to ultimately outperform the market.

However, for most investors, the risk of losing 10% of their portfolio value if just one of their stocks ceases trading could be too great. Therefore, one solution could be for investors to utilise a significant proportion of their portfolio for their ten best ideas. The remainder could be held in a tracker fund or in a larger number of a wide range of shares. This may allow an investor to have the ‘best of both’, in terms of benefitting from their own ability to a significant extent, while also having some diversification.

Clearly, an investor’s own risk tolerance will have a major bearing on the level of diversification that they utilise. But for many investors, backing their own judgment while also having a degree of diversity could be a prudent option.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Peter Stephens owns shares in Tesco. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Affectionate Asian senior mother and daughter using smartphone together at home, smiling joyfully
Investing Articles

How I’d invest my first £20k ISA to target £4,900 a year from dividend shares

Looking for dividend shares in a new Stocks and Shares ISA, and want diversification too? Here's how I'd go about…

Read more »

Passive income text with pin graph chart on business table
Investing Articles

Yields of up to 7%! I’d consider boosting my income with these FTSE dividend stocks

The London market has some decent-looking dividend stocks right now, and I’m tempted by these two for growing income streams.

Read more »

Young mixed-race couple sat on the beach looking out over the sea
Investing Articles

I’d put £20K in an ISA now to target a £1,900 monthly second income in future!

Christopher Ruane shares why he thinks a long-term approach to investing and careful selection of shares could help him build…

Read more »

Mature couple at the beach
Investing Articles

6 stocks that Fools have been buying!

Our Foolish freelancers are putting their money where their mouths are and buying these stocks in recent weeks.

Read more »

Black woman using loudspeaker to be heard
Investing Articles

I was right about the Barclays share price! Here’s what I think happens next

Jon Smith explains why he still feels the Barclays share price is undervalued and flags up why updates on its…

Read more »

Investing Articles

Where I’d start investing £8,000 in April 2024

Writer Ben McPoland highlights two areas of the stock market that he would target if he were to start investing…

Read more »

View of Tower Bridge in Autumn
Investing Articles

Ahead of the ISA deadline, here are 3 FTSE 100 stocks I’d consider

Jon Smith notes down some FTSE 100 stocks in sectors ranging from property to retail that he thinks could offer…

Read more »

Young female business analyst looking at a graph chart while working from home
Investing Articles

Why I think Rolls-Royce shares will pay a dividend in 2024

Stephen Wright thinks Rolls-Royce shares are about to pay a dividend again. But he isn’t convinced this is something investors…

Read more »