How many investments do you need in your Stocks and Shares ISA?

The best way to protect a Stocks and Shares ISA from permanent losses is through diversification. But how many investments do you need to do this?

Stephen Wright

Stephen has a PhD in Philosophy and teaches at the University of Oxford. He's an enthusiastic Warren Buffett follower and focuses on buying quality businesses at sensible prices. He's also a podcaster with the PlayingFTSE show.

Published 26 April, 7:56 am BST

| More on: BRK.B

I own 16 investments in my Stocks and Shares ISA (and another five outside). Is that enough?

I think it is. But in terms of diversification, not every stock is the same.

Why diversify?

Investing always comes with risk. Even the best in the business can’t always see everything that’s going to happen in the future. The most effective way to protect against this is by building a diversified portfolio. That limits the impact of any individual threat.

There is, however, an obvious downside to this. Having more investments increases the number of risk factors a portfolio is exposed to. For example, adding some bank stocks to a tech-focused portfolio limits the impact of rising interest rates. But it makes a recession a bigger threat.

So how do investors know whether diversification is making things better or worse? I think there’s an important rule they can use.

Warren Buffett

One of Warren Buffett’s principles is that risk doesn’t come from volatility. It’s the result of not knowing what you’re doing.

I think this is right. Nobody – including Buffett – knows everything that’s going to happen, so some risk is inevitable. Diversification limits the impact of these things we can’t foresee. But if it creates more than it replaces, that’s not really helpful.

That means investors shouldn’t buy things they don’t understand just for diversification. I think that’s counterproductive.

Investors can, however, have a clear sense of what they don’t know. And some stocks offer better protection than others.

Ready-made diversification

Buffett’s own Berkshire Hathaway (NYSE:BRK.B) is a good example. It has subsidiaries in insurance, energy, retail, and more.

The firm’s stock portfolio is relatively concentrated, with a handful of major holdings. But firm is much more than these investments.

This doesn’t entirely eliminate risks. A major natural disaster or cyber incident could end up costing the company a lot. That’s inevitable in the insurance industry. But the aim in both insurance and investing is to manage risk, not eliminate it.

Berkshire does this with a strong balance sheet and a disciplined approach to underwriting. And I expect this to continue now that he’s retired.

Outlook

Berkshire Hathaway offers a lot in terms of diversification for my portfolio from one stock. But that’s not the only reason I own it.

The firm’s financial position gives all of its subsidiaries a big advantage. The rail and energy divisions are good examples. In both cases, their competitors have high debt levels. By itself, this isn’t a huge issue given the predictable nature of the businesses.

Berkshire’s operations, however, don’t have to think about this at all. Their managers also don’t have to deal with quarterly investor calls.

That’s what I see as the company’s key strength. And I think it’s going to be a durable and important one.