I’ve always believed in the power of smart investing, and one of the key components of any good investment strategy is portfolio size. Understanding the right portfolio size can make a significant difference between achieving your financial goals and falling short. Let me walk you through why the right portfolio size is so crucial.
First off, diversification is king. With a larger portfolio size, you can spread your investments across various asset classes, industries, and even geographical locations. Think about it—if you put all your money into just one or two stocks, you’re taking on a considerable amount of risk. For instance, during the 2008 financial crisis, the S&P 500 index dropped by almost 57%. Investors with a diversified portfolio managed to cushion the blow somewhat, compared to those who held only a few stocks.
Another factor is the law of large numbers, which economists often talk about. It basically means the larger your sample size, the less likely you are to see anomalies. This rule translates to investing: by having more stocks in your portfolio, you reduce the risk of any single stock’s poor performance drastically affecting your overall returns. For example, if you own 50 stocks, the failure of one would only impact about 2% of your portfolio. Contrast that with a portfolio of 10 stocks, where one bad investment can affect 10% of your portfolio.
New investors often ask me, what’s the ideal number of stocks to hold? The answer isn’t one-size-fits-all but aiming for somewhere between 20-30 stocks provides a good balance between diversification and manageability. The author of “A Random Walk Down Wall Street,” Burton Malkiel, even recommends holding around 20-30 stocks to achieve optimal diversification. Not too many to manage but enough to minimize risk.
Now, some people wonder if it’s possible to have too many stocks. Absolutely. When your portfolio grows too large, say over 50-70 stocks, managing and keeping track of each investment becomes cumbersome. Mutual funds, which are managed by professionals, often own hundreds of stocks; still, even fund managers struggle to beat the market consistently. This suggests there’s a limit to effective diversification.
Let’s not forget the costs involved. Buying and selling stocks incurs transaction fees. For smaller portfolios, these fees can quickly eat into your returns. Suppose you invest $50,000 and make 20 trades in a year. If each trade costs you $10, that’s $200. For larger accounts, these fees are less significant relative to the portfolio size, but they still add up. And then there are tax implications. Frequent trading can lead to short-term capital gains, which are taxed at a higher rate compared to long-term gains.
Consider the specifics of sectors or asset classes. Owning stocks from different economic sectors—like technology, healthcare, consumer goods—spreads the risk even further. During the dot-com bubble, tech-heavy portfolios suffered massive losses, whereas diversified portfolios, which included consumer goods and healthcare, fared much better. It’s another testament to the power of diversification within your portfolio.
Personally, I also like to include different asset classes like bonds and international stocks to hedge against market volatility. Historically, bonds offer stability and lower risk, making them a good counterweight to the higher risk and higher reward nature of stocks. In 2020, when the stock market plunged due to the pandemic, bond funds like iShares Core U.S. Aggregate Bond ETF (AGG) remained relatively stable.
Additionally, your age and financial goals should influence your portfolio size. For instance, if you’re close to retirement, a more conservative portfolio with a few large-cap stocks and bonds may be suitable. Conversely, younger investors might prefer a more aggressive portfolio with more stocks, especially in high-growth sectors like technology or healthcare. According to Investopedia, a classic rule of thumb is to hold a percentage of equities equal to 100 minus your age. So, a 30-year-old might hold 70% equities and 30% bonds.
Some people might argue that exchange-traded funds (ETFs) provide all the diversification you need in a single investment. While ETFs are indeed convenient, owning individual stocks as part of a more extensive portfolio lets you capitalize on specific opportunities. For example, while an ETF might dilute gains from a booming stock like Tesla, holding Tesla stock individually can offer a much higher return potential.
Even companies are mindful of portfolio size when it comes to their investments and holdings. Take Warren Buffet’s Berkshire Hathaway, which maintains a well-diversified portfolio, albeit in stocks he has strong convictions about. Berkshire’s portfolio comprises around 45 different stocks as of my last check. It’s diversified enough to mitigate risk but concentrated enough to manage effectively.
One can’t overlook the role of rebalancing, a strategy most financial advisors advocate. Periodic rebalancing ensures your portfolio aligns with your original investment strategy, often requiring you to buy low and sell high. For example, if your target allocation is 60% stocks and 40% bonds and stocks perform well over the year, you might end up with a 70/30 split. Rebalancing would involve selling some stocks and buying bonds to revert to the 60/40 balance, maintaining risk management.
In the end, the right portfolio size depends on individual needs, goals, risk tolerance, and market conditions. But always keep in mind the principles of diversification, manageability, and cost-efficiency. These factors collectively ensure you’re on the right track to meeting your financial goals.