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Today we’re getting back to investing basics. Investing 101. How many stocks should you own? Whether you like dividend investing, or you focus on growth stocks, if you own too many stocks then a good performing stock will have very little affect on growing your money because you’ve spread your money way too thin. But if you own just a few stocks, you are taking on a huge risk where you could either make a lot of money, or lose all your money. When it comes to the finance community, this is a fiercely debated question, and no one seems to know the answer.
The most important variable to answer this question is a word you may have heard before – it’s called – DIVERSIFICATION. It means you take your money, and instead of putting it in one place, you spread it out, across multiple different stocks from different TYPES of sectors, and different types of industries. Doing this means you protect your money from going up and down all at once. It’s important because what it does, is it reduces your risk to the volatility of the stock market.
The best amount of stocks to own is whatever it takes, to achieve “diversification”. The problem is, no one can agree as to what that means. Diversification is a sliding scale. In the world of money investing nerds, if you ask them “what do you consider diversified”, you’ll very quickly find that there’s many different opinions but the most popular amongst them, is that you should own between 20 to 30 stocks. But is that really fact?
In 1970, the Journal Of Business published what would become that popular opinion when they discovered that you could essentially recreate the benefits of diversification that you’d get with owning the entire New York Stock Exchange by owning only 32 stocks. That study showed the risk of owning around 30 stocks was low enough to compare to owning the entire New York Stock Exchange. But, that was an old model. Using modern calculations, what they found was that risk reduction, is not necessarily the same as diversification, even though that’s one of the investing benefits.
In an updated study done by Sur & Price, they used the R Squared formula. “R-squared will give you an estimate of the relationship between movements of a dependent variable based on an independent variable’s movements.” Put simply, If a stock has a LOW R squared result, it means that specific stock, does not generally follow the stock market’s price performance. A high r squared result, means the stock price generally copies what the overall stock market is doing.
When analyzing the stock market, 39% of stocks were unprofitable, 18.5% of stocks lost 75% or MORE, 64% of stocks performed worse than the Russell 3000 index (which is something that tracks the entire US stock market), and 25% of stocks were responsible for all of the stock market’s price increases. Think about that for a second, 1/4 of stocks were responsible for all the price increases.
The general rule of thumb is that as a beginner, it’s better to own more stocks. In fact, it’s better to buy into an exchange traded fund that tracks the overall market like VOO or VTI. With just that one stock, you will own thousands of stocks, in just one piece of stock. As you become better and you can devote more time to this, if that’s something that you’re interested in, then you should own FEWER stocks.
If you own an ETF that tracks the broad S&P500 stock market, you will outperform the majority of professional stock pickers. For my portfolio, I’ve essentially recreated my own index fund that I have more control over, and it’s a little cheaper, but the downside is that I’m basically doing as good as the stock market, so I might as well own an index at this point if I want a similar result – which is also what I’m focusing more on with stocks like SPHD that are monthly dividend payers.
Maybe you want to take more risk, in which case, you might do better sticking to a stock portfolio of only 10 stocks that are heavily weighted in the tech sector.
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