How many stocks should you have in your portfolio?

How many stocks to own is a question that has exercised the minds of investors ever since the first stock market opened. There are many possibilities and I hope that by the end of this article you’ll have a good idea about what might be the right number for you.

Buying the whole market

There are over 600 companies in the FTSE All-Share Index, representing 98% of the market capitalisation of businesses on the London Stock Exchange. You’d need a sizeable sum to invest in all of these companies individually, due to dealing costs. However, even with a mean budget, you can buy a low-cost fund that simply tracks the index.

Is investing in an index tracker a good idea? The short answer is — for many people — yes. Legendary US investor Warren Buffett explains why: “Most investors … have not made the study of business prospects a priority in their lives. If wise, they will conclude that they do not know enough about specific businesses to predict their future earning power.” But, as Buffett adds, by making regular investments in an index tracker, “the know-nothing investor can actually out-perform most investment professionals. Paradoxically, when ‘dumb’ money acknowledges its limitations, it ceases to be dumb.”

So, if you don’t have the time or inclination to study individual businesses as a priority in your life, an index tracker is a great idea.

A concentrated portfolio

At the opposite extreme, while having all your wealth in a single stock isn’t a good idea for anyone, some of the world’s most successful investors have argued for owning a very concentrated portfolio.

Buffett again: “If you are a know-something investor, able to understand business economics and to find five to ten sensibly-priced companies that possess important long-term competitive advantages, conventional diversification makes no sense for you … I cannot understand why an investor of that sort elects to put money into a business that is his 20th favourite rather than simply adding that money to his top choices …”

Now, I would suggest that most investors would find holding five to ten stocks simply too unnerving. Certainly, I couldn’t sleep easy with such a concentrated portfolio. And indeed, Buffett himself, in practice, comes closer to his mentor Ben Graham’s recommendation of 10 to 30 stocks.

A middle road

If you hope to earn a significantly higher return than you might get from a humble index tracker, you have to own a relatively small number of companies. But the fewer you own, the more serious will be the adverse impact if your judgement proves awry on even one or two.

Equally, the more you own, the less you’ll know about each business, simply due to restraints of time. Unless your whole waking life is spent studying companies, I’d say that by the time you get over about 30 you’re into the realm of not being able to keep up with the progress of each business in the depth needed. Over about 50 and you’re into the realm of ‘diworsification‘ and reducing your chances of earning a significantly higher return than a no-effort index tracker.

In summary, there’s no ideal number of stocks to own. An index tracker will be the best choice for many people, while for investors in individual stocks, available time and tolerance of risk are important considerations in sizing your portfolio.

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G A Chester has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.