How Many Stocks Should I Hold - Right Now!

28th Feb by Mark Simpson

12 comments 2045 reads

As part of the Building a Portfolio series on the Stockopedia Academy, I wrote about how many stocks an investor should hold. The truth is there is no magic number. Each investor has unique circumstances which means they should be more or less diversified.

The value of diversification

If an investor holds too many stocks or, even worse, many different funds, they can end up with an expensive index tracker. The extra costs pretty much guarantee an underperforming portfolio. The consequences of holding too few stocks is much more severe. The reason is that it exposes an investor to what is known as idiosyncratic risk. That is, risk that they have to bear and cannot be avoided. Even the greatest companies eventually fail, and every stock can go to zero. Indeed, a complete wipeout, or a large loss that comes close to this, can happen so suddenly that an investor cannot sell to escape it. Take, for example, WANdisco, now renamed as Cirata (LON:CRTA) . When it was suspended on 9 March 2023, this was a High Flyer with a share price of £13.10. When it came back to the market on 25 July, the share price was 49p, and investors had lost 96% of their money:

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The problems with this sort of loss in an undiversified portfolio are two-fold. The first comes when an investor has insufficient time or capital to recover from a drop of this magnitude. The second is when losses cause an investor to behave irrationally. There are numerous ways a significant loss can lead to irrational behaviour, but they typically consist of inappropriate adjustment to risk tolerances. This can go either way. An investor can become risk-averse and act like a rabbit in the headlights, unable to take advantage of favourable opportunities. Or they can become highly risk-seeking, looking to win back the recent loss, often by betting big in the exact stock they have just lost money in. Both these strategies will likely lead to further losses (or lack of gains).

The key to successful investing is to hold enough companies to be able to cope with unexpected adverse news without behaving irrationally, as well as being diversified enough for the performance of their portfolio to recover from these setbacks before investors need the money. The following table…

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Guybrush

28th Feb

29th Feb

"...including how rangebound markets may make it difficult for momentum investors to generate positive returns. A momentum investor will want to focus on the few UK ideas they have that exhibit strong momentum or even search in international markets with a clear positive trend."

A superb article, and such an insightful statement, one that could be worth many thousands of pounds to the shrewd trader. I was a bottom fisher in AIM shares for years but decided recently to trial a momentum strategy, which hasn't been great so far. Based on charts, I've realised that the UK markets which over the decades is actually a sideways market, and is no good for momentum investing/ trading, unless catching the transition from a bear to a bull market, and then the maximum hold should be no longer than 3 years for maximum capital gain. That steep decline and just as steep recovery(though longer) occured only twice in the last 15 years, once in 2007-8, the financial crisis, and the other in 2020 during covid, so the opportunity for large capital gain was rare. There were milder declines, and recoveries of course, which would have been very profitable. So, broadly speaking, a rangebound strategy for UK markets works best for capital gain, unless catching the start of a bull market, or looking for income from dividends.

Contrast that to the US markets, an eternal money machine, which as you mention shows a definate long term uptrend. Momentum and buy and hold(for as long as possible) would have seen remarkable upside, and that's why holding for a decade or two in the right US stocks could have made one millions.

Indie

Hi Mark, v interesting read, lots to think about.

I notice there isn't a link to this on the Today page, but three Week Aheads. While they are excellent, surely you could bump the oldest one off with this article?!

Alphaflight

As I recall, Modern Portfolio Theory says that you need >=12 stocks in a portfolio (different sectors) in order to diversify the unsystematic risk away (the risk associated with a specific stock / sector). With simple mathematics you can actually determine this figure. Note the chart below, the market risk (systemic risk) cannot be diversified away in a portfolio.

The famous Mathematician Benoit Mandelbrot showed that 90 to 120 stocks were a better bet...

Mark Simpson

Yes, you are right; diversifying away the idiosyncratic (unsystematic) risk still leaves the systemic, also known as market risk. If the stock market has a big down day, then we are likely to take a bath, too, no matter how good our long-term stock-picking record is. This is all the more reason to be cautious about how much idiosyncratic risk you are willing to bear.

However, I don't think the 12 stocks remove the majority of the idiosyncratic risk. I considered this argument in my book, so I'll simply quote myself on this one!

One of the objections to greater diversification is that the more stocks you own the more you end up tracking the broad stock market indexes. This idea comes from research in 1970 by Lawrence Fisher and James H. Lorie when they were looking into how many stocks you need to own to remove variability from a portfolio.[i] At that time, investors wanted exposure to the broad stock market but index funds and ETFs were not widely available, and the cost of maintaining a portfolio of hundreds of stocks was costly. Fisher and Lorie found that portfolios of just 32 stocks chosen at random removed 95% of the variability in the distribution of returns.

Investors often misinterpret this research to mean that if they own more than 30 stocks they are simply tracking the market. This misses a crucial point, though: stock-pickers are not choosing stocks randomly. If you have skill in stock-picking there is no reason that a portfolio of 30 or more stocks should track the market. Another issue with relying on the Fisher and Lorie study is the measure they used: the standard deviation of returns. A more recent study used the better measure of tracking error and found that even 60 randomly selected stocks only removed 88% of the tracking risk.[ii]

[i]. Lawrence Fisher and James H Lorie, Some Studies of Variability of Returns on Investments in Common Stocks, The Journal of Business, vol. 43, no. 2, 1970, pp. 99-134.

[ii]. Ronald J Surz and Mitchell Price, The Truth About Diversification by the Numbers, The Journal of Investing, vol. 9, 2000, pp. 93-95. 10.3905/joi.2000.319444.

Thanks for the heads-up. I am not quite sure how the algos work on this one, but it is appearing on the "Today" page for me now!

Mark Tughan

Thanks for another superb article Mark , you're a real asset to the Stockopedia community!

Monty Carlo

(A post I wrote in Oct 2021 that has vanished into the bowels of the Discuss section - can anyone find it via a search? I bet you can't despite "Diversification" being in the title. No wonder people don't invest time in the Discuss section.)

https://www.stockopedia.com/co...

I originally wrote the below in an SCVR thread, but Stocko is very light on detail when it comes to portfolios and risk management so I thought I'd add as a topic here:

On diversification in general there seem to be four approaches:

1. Put your eggs in one basket - watch it very carefully (Warren Buffet)
2. Hold the maximum number of shares you have the time to monitor
3. Hold a concentrated portfolio to maximise divergence from a performance benchmark (i.e. maximise return on stock selection)
4. Take the mathematical approach of seeking to diversify away a large chunk of the stock specific risk.

I would argue Option 1 is for the full time pros who know their companies AND can afford to take a big hit without changing their lifestyle, or for the gambler who enjoys the ride.

Option 2 is for the keen amateur investor with a day job holding positions in a SIPP alongside a company pension, the enthusiastic private investor using an ISA etc alonside other savings.

Option 3 is for fund managers who need to market their fund and demonstrate they are not index huggers. By all means hold these funds (e.g. Fundsmith) but don't put all your money into just one of them! Hold a basket of them and mind the overlaps.

Option 4 is for those private investors who are "all-in" and rely on their portfolios to fund their livelihoods. It is not always possible to spot fraud, the unexpected happens, and the professional fund managers frequently get things embarrassingly wrong too. Diversify to protect yourself because you realise just how ignorant everyone is, and nobody can predict the future. The maths says you can diversify with as few as 20-25 holdings, but in practice you are looking at 50-70 stocks once you take into account sector concentrations and factor correlations. If you include liquidity risk because you hold small & mid-caps then it can be sensible to hold well over 100 positions. I will take some flak for saying this as it isn't fashionable, but in investment being fashionable doesn't work for long.

Of course you can cut corners with ETFs, investment trusts etc, at the expense of paying someone else to diversify for you. They make a lot of sense for overseas markets... just try dealing in Japanese equities or reclaiming withholding tax from some other markets.

In fixed income you have an asymmetry of return (upside is the coupon, downside is 100% wipeout if no recovery post default). Corporate bond portfolios should be 125+ holdings or even higher (HY/junk being slightly different).

It costs very little to diversify, and over-diversification never killed anyone.

Lincoln Green Imp

A good write up. A good article on this subject I found on Stockopedia is 'How many stocks should you own in your portfolio? ' by Ed Croft. After reading that I found that I stopped searching for articles on how many stocks to hold.

1st Mar

A great summary, thanks for digging it out and reposting.

doctor dave

Terrific article Mark. I hope you are selling lots of copies of your book because you deserve to with your clarity of thought and explanation.

I opened as ISA for my son and even with only 5 AIM stocks I was impressed how much it ebbs and flows with the overall market.

I'm in the process of trimming down from 170 stocks to 30 stocks (currently at 70 and benefitting) with bigger bets on each.

Silverback01

I think that the optimal number of stocks in my own portfolio, is less for me about reaching a magic number and more about achieving a balance that aligns with my personal risk tolerance, investment horizon, and market opportunities. When I try and navigate the fine line between over-diversification and concentrated risk, a thoughtful selection and ongoing review of my investment positions becomes paramount. I try (and I am not perfect at this let me say), let my strategy evolve with the markets, whilst always staying true to my investment principles and risk appetite.

How many stocks should I hold - right now!

The value of diversification

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Mark Simpson

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