Diversification is one of the first rules of investing that most financial advisors and experts talk about. Diversification refers to investing in a wide mix of investments within a portfolio. Here you do not put all your eggs in one basket, which implies distributing your wealth across different instruments. When you do so, you lower risk and increase the chances of earning more, even during times of market volatility. Since no two investments are likely to perform the same at a given time, diversification offers your money a better chance to earn a profit.
Diversification can be done through different means. You can add multiple asset classes, like stocks, bonds, cash, real estate, etc. Similarly, you can invest in various sectors, such as technology, pharmaceuticals, tourism, and others. You can also diversify through different market capitalizations, like small, mid, and large-cap companies.
No matter the asset allocation, keeping a healthy mix of stocks is always advised, especially if you are not nearing retirement anytime soon. Equity or stocks carry high risk compared to other asset classes but have also historically delivered better returns. Stock investing can be ideal for multiple long-term goals, such as purchasing a house, retirement, planning a child’s higher education expenses, healthcare planning, and others. However, in order to gain from the stocks you invest in, you must pick the right one. Consider consulting with a professional financial advisor who can help build a diversified investment portfolio based on your financial needs and future goals.
Learn more about the total number of stocks ideal for a balanced portfolio, how much of your portfolio should be in one stock, and ways to create a well-diversified that can bring you to your desired financial goals.
How many stocks should I have in my portfolio?
When it comes to your stock investments, there is no fixed amount that you can own. It may be advised to add stocks based on your risk appetite, goals, investment budget, and interests. Some experts recommend keeping a minimum of 20 and a maximum of 60 stocks in your portfolio. However, you should analyze your goals first to pick a figure for yourself. In addition to this, it is also essential to understand that stocks are not just investments. They also indicate your ownership of a company. When you buy stocks, you get proportional ownership in the business. Therefore, the company’s ideals, area of operation, technology, etc., must align with your beliefs and interests. This is why financial advisors often recommend getting to know the business you invest in and picking stocks only if you believe in the company and align with its vision for growth.
Once you have researched and shortlisted companies for investment, you can stick to the 20 to 60 number. As explained above, one of the most critical things in investment is diversification. Here’s what you need to know about this:
1. Less than 20 stocks
When you start investing in your 20s, you may find the process overwhelming. Therefore, it is alright to start slow with a few stocks in your possession. However, once you understand the market better, it may benefit you to gradually increase your stock investments. Having less than 20 stocks makes your portfolio concentrated and limits your chances of growth. It also increases risk because of under-diversification, as your portfolio only focuses on a particular sector, industry, or geography. Therefore, try to go over the limit of 20.
2. More than 60 stocks
Adding more than 60 stocks can make it hard for you to manage your investments. This is also known as over-diversification. Stock investing can be volatile, with several highs and lows. Therefore, monitoring your investments closely, reviewing your portfolio periodically, and taking the necessary action as and when required is essential. A number above 60 can be hard to monitor with other investments and professional and personal commitments. The more stocks you add, the more time you need to spend reviewing and tracking your portfolio.
3. Between 20 and 60 stocks
This is the ideal number of stocks to own. A number between this range will offer optimal diversification and, at the same, be easy to manage and monitor. As discussed above, different investments are expected to perform differently at a given time. Therefore, you will always find your stocks showing varying returns. Optimal diversification will ensure that you are never entirely in the red zone and are able to balance out the losses with some profits.
Now that you have the answer to how many stocks you should own, let’s move on to the next part.
How to pick stocks for your portfolio
The number of stocks is not only limited to figures but also the types of stocks you should invest in. There is always a dilemma between owning more shares of the same company or fewer stocks of different companies. The solution can be subjective depending on market dynamics and your risk appetite. If you have surplus money that you wish to invest, you may consider buying more stocks of the same company as long as there is potential for growth and you have researched well. However, if you are not able to back your decision with evidence, it may be better to add other companies to your portfolio. Arriving at a conclusion can be tricky in such a situation. However, getting in touch with a financial advisor can help you understand how much of your portfolio should be concentrated in one stock.
Typically, you must pay attention to the following things when picking stocks to ensure optimal diversification:
The performance of your stocks will differ for different sectors. For instance, the technology sector is undergoing severe losses at present, with top companies laying off employees to curtail losses as the country moves into a speculated recession. If all of your money is invested in similar tech companies, you increase your risk substantially. However, if you move your money to other sectors like consumer goods, energy, healthcare, etc., you will be able to distribute risk and curtail your losses.
Just like the sector, you can also invest in different economies. International stocks can offer you exposure to global markets. This is a great way to expand your horizon and be a part of global growth opportunities. However, it is essential to note that international stocks can be affected by several global factors, such as droughts, floods, country-specific regulations, policies, and more. Therefore, it is necessary to research well and consult a professional financial advisor to better understand the risks and return potential.
3. Market capitalization
Market capitalization refers to the dollar value of a company’s outstanding shares. It is calculated by multiplying the total number of all outstanding shares by the current market value of one stock. Companies are divided into three types based on market capitalization:
1. Large-cap companies:
These companies have a market cap of $10 billion or more. Large-cap companies are big, established companies. They are relatively more stable and may be able to withstand several market lows. Therefore, they may be the least risky out of the three. However, the scope for growth is also limited as these companies are already at the top.
2. Mid-cap companies:
These companies have a market cap of $2 billion to $10 billion. Mid-cap companies are medium-sized. They are established but still not at the top. As a result, they contain medium risk and can deliver medium returns.
3. Small-cap companies:
These companies have a market cap of $300 million to $2 billion. These include new and upcoming businesses that may have immense potential to grow. However, the risk involved is high, and these companies are not well-established and just starting out.
You can pick stocks based on your risk appetite. However, keeping a blend of all three market caps can offer stabilized returns as long as you choose the right companies and shares.
How often should you review and revise your stock portfolio?
Since equity is a volatile asset class, reviewing your portfolio every now and then is essential. The recommended frequency for a portfolio review is usually once a quarter to once or twice a year. It is advised not to review your portfolio sooner than this, as that can lead to stress, anxiety, and panic selling.
The length for which you hold on to your stocks can depend on several factors. For instance, some experts recommend holding on to a share for a year or more to gauge its performance. It is vital to give your stocks some time before you remove them from your portfolio. Also, holding on to your stocks for the long term can help you save tax. Long-term capital gains tax is taxed as follows for 2023:
On the other hand, short-term capital gains tax is added to your total taxable income and taxed accordingly. The highest tax rate for this can be as high as 37%. Evidently, even at the highest tax rate of 20%, long-term capital gains tax is lower than 37%.
Moreover, constant swapping between stocks can take time and effort. Most people do not have the time to monitor their investments so closely. A majority of investors are professionals who lead busy lives. For them, investing is a way to earn returns and prepare for future goals like retirement, financial security for their family, home purchase, and more. They do not necessarily have the interest or inclination to track companies and corporate decisions with such intricacies.
A buy-and-hold approach may be more suitable for these investors. Experts like Warren Buffett also endorse this strategy. In fact, Berkshire Hathaway, for which Warren Buffett is the CEO, had an equity portfolio with 40 stocks at the end of 2021. 41% of these were a single stock. Therefore, it may be more profitable to get a hold of a few stocks that you like, understand, and see potential in rather than swapping back and forth without proper knowledge.
How can you start investing in stocks?
There are a number of ways to invest in stocks. Here are some options:
1. Direct investing:
The most straightforward way to invest is through a broker. You can choose a broker and start investing directly in the stocks of your choice. There would be no interference or bias from anybody, and you alone will decide the stocks you want to invest in. However, you would have to pay brokerage. So, keep this in mind and accordingly pick an option.
A 401k retirement account is a tax-advantaged company-sponsored plan that allows you to invest in different securities like stocks, bonds, exchange-traded funds, etc. While the 401k does not allow you to invest in individual stocks directly, you can do so through mutual funds and exchange-traded funds. The choice of investments can differ for different plans. The selection may also be limited, but this is a good way to enhance your portfolio with stock options.
3. Individual Retirement Account (IRA):
The IRA is another tax-advantaged retirement account similar to the 401k. However, it is not company-sponsored. You can invest in stocks through your IRA, just like a 401k.
4. Stock mutual funds:
Stock funds are mutual funds that invest in equity or stocks of other companies. They may invest in small-, mid-, or large-cap companies. Stock funds are managed by professional fund managers who decide the portfolio, buy and sell securities, and manage your money. If you want a diversified stock portfolio but do not want to invest in stocks directly, you can consider stock funds. The manager will do the work on your behalf, and you will be able to profit through returns.
5. Index funds:
Index funds are passive funds that mimic the benchmark index they follow. They invest in the same stocks as the benchmark index with the aim of delivering the same performance. These funds can be good for instant diversification as they offer exposure to multiple companies at once, just like stock mutual funds.
Questions like how many stocks you should own or how much of your portfolio should be in one stock can be overwhelming and hard to navigate. There is a wide pool of advice that can sometimes pose opposing ideas and confuse you. Therefore, sticking to an average of 20 to 60 stocks can be advised if you invest directly in stocks. This can be easy to manage and allow you to seek the benefit of optimal diversification. However, if you are new to investing or lack time to manage your investments, it may be advised to invest in stocks through other options like mutual or index funds. This removes the burden off your shoulders and delivers similar growth.
No matter what you choose, it can help to consult a professional financial advisor to clear any doubt and employ a comprehensive and suitable investment plan. Use the free advisor match tool and get matched with 1-3 qualified financial advisors who may be able to help you pick the right stocks for a diversified portfolio. All you need to do is answer a few simple questions about yourself and the match tool will help connect you with advisors suited to meet your needs.