Like most other aspects of stock market investing, there is no single and definite answer to this very relevant question.
An often asked and debated question is, how many stocks should there be in one’s portfolio? Like most other aspects of stock market investing, there is no single and definite answer to this very relevant question. It mainly depends upon your risk profile, return expectations, research bandwidth and the time period of investments.
I will delve into all these three aspects in detail. The first important aspect to look into is the risk aspect. The more stocks you hold in your portfolio, the lesser is the risk that you are carrying. As they say there is safety in numbers. Chances of any one company going out of business and stock value going to near zero value is always there, but larger the number of stocks you carry in your portfolio, the impact of such accidents on your overall returns gets minimised.
The second aspect is the return expectations. Return probability usually keeps going down as the number of stocks increase. Here the reverse logic of risk usually applies. Impact of any high-return stock or stocks on the overall portfolio performance keeps going down as the number of stocks go higher. So, the higher the return expectations, the lower should be the diversification. Focus on a few high-conviction ideas is an ideal way to generate fabulous returns.
Needless to say, risk of loosing money keeps getting higher as the concentration in the portfolio keeps increasing. Risk and return, thus, normally move in the opposite directions and getting the right balance is the first important step before any portfolio investments start. Research capability or access to quality research is another factor to be kept in mind while deciding the number of stocks you wish to hold. The more well-researched the stock ideas are, the lower is the risk that you carry on them. Hence, the need to carry a large number of stocks can significantly reduce if you have access to or capability of quality research. Time that you plan to hold your investments for is important as timing the markets or determining when any stock would generate the desired returns is impossible to ascertain. Hence shorter the time you have more would be the diversification or the number of stocks that you need in your portfolio.
Let me conclude by saying that a financial plan which includes risk profiling should be the starting point of any investment plan. The financial plan will serve as a guide in making an ideal portfolio keeping our temperament and needs in mind. It will simultaneously also help ascertain the number of stocks we need to hold in our portfolio.
(By Ashish Kapur, CEO, Invest Shoppe Ltd)