Ideal number of stocks to hold in a Portfolio

Individual Investors who manage their own portfolios often grapple with the question of the ideal number of stocks that they should hold in their portfolio. This question is very relevant since a low number of stocks can significantly increase portfolio risk while a high number of stocks can considerably dilute portfolio returns and also increase transaction costs. This question is particularly relevant to those investors who are prone to buying stocks from ‘stock tips’ that come their way via various channels, and who therefore have to decide at some point of time whether enough is enough.

It is pertinent to note that when determining the number of stocks to be held in the portfolio, investors implicitly deal with two types of risk – systematic and unsystematic risk. Unsystematic risk is the risk associated with a particular company or Industry. It can be reduced to near zero levels by holding a portfolio of well diversified stocks.  Systematic risk on the other hand, is the risk associated with the entire stock market. No amount of diversification in your portfolio can reduce it.

Hence the exercise behind trying to understand the ideal number of stocks to hold in a portfolio is one of striking the right balance between minimizing unsystematic risk and maximizing portfolio returns. While there is no right answer to this question, the factors that will influence the answer are

• The Portfolio corpus
• Stock market that you are investing in (US, India, etc.)
• Your Investment time horizon
• Your Risk tolerance

In this context, the celebrated economist John Maynard Keynes proposed in 1938 that investors should hold concentrated investment portfolios. He believed that skilled investors can maximize their long-term returns through a deliberate selection of well researched and diversified stocks. This concept has stood the test of time to this day as confirmed by the fact that fund managers of most diversified equity mutual funds hold no more than 30 stocks in their portfolios. While such funds have access to considerable research resources from a variety of sources, individual investors generally lack these resources. Researching quality stocks with the potential for generating above average returns in the long runs takes considerable amount of time and resources.

Hence at Attainix Consulting, we believe that as a thumb rule individual investors should hold no more than 15 stocks in their portfolio at a given time, which is half that held by most equity mutual funds. We also practice this philosophy when advising our Clients for the icAdvisor service, wherein depending on the four factors enumerated above, we recommend between a minimum of 5 and a maximum of 15 well diversified stocks. Even the back-testing of the icTracker software has been performed using a maximum holding of 15 stocks at any point in time and the results published on the website only confirm the superior returns that can be had from a concentrated portfolio, with the minimum of risk!

Sources:

1.   concentrated-stock-portfolios.html. (n.d.). Retrieved Feb 24, 2017, from www.maynardkeynes.org: https://www.maynardkeynes.org/concentrated-stock-portfolios.html

2.   optimalportfoliosize.asp. (2005, July). Retrieved Feb 24, 2017, from www.investopedia.com: http://www.investopedia.com/ask/answers/05/optimalportfoliosize.asp