Whenever a newbie investor starts building their stock portfolio, the most important question that comes to their mind is how many stocks to buy? How many stocks should you own for a diversified portfolio? In other words, how many stocks are too few, and how many stocks become too many in a portfolio?
In general, there is no correct answer to this question and the response may vary according to your investment goals. However, there are few thumb rules for defining the number of stocks in your portfolio.
In this article, we’ll discuss how many stocks should you own for a diversified portfolio. However, first, we should understand the meaning of a diversified portfolio.
What is a Diversified Portfolio?
A diversified portfolio is investing in different stocks from dissimilar industries/sectors in order to reduce overall investment risk and to avoid damage to the portfolio by the poor performance of a single stock.
For getting good returns from your investments, it’s important that your stock portfolio is well diversified. Both under diversification and over-diversification is adverse for an investment.
- Under-Diversified portfolio has more risk as the poor performance of a single stock can have an adverse effect on the entire portfolio.
- On the other hand, an Over-Diversified portfolio gives low returns and even good performance of a single stock will lead to a minimum positive impact on the overall portfolio.
As a thumb rule, as the number of stocks in the portfolio increases, the portfolio becomes more diversified, and risk decreases (but the net profit on the portfolio may be lower).
In a similar way, as the number of stocks in the portfolio decreases, the portfolio becomes under-diversified, and risk increases (but profit on the portfolio may be higher).
How Many Stocks Should You Own For A Diversified Portfolio?
In general, here’s a thumb rule on how many stocks should you own for a diversified portfolio:
— Minimum 3 stocks from Different Industries
There should be at least three stocks from dissimilar sectors/industries in your portfolio.
— Maximum number of stocks should be 20
The maximum number of stocks in any retail investor’s portfolio should be 20. If the number of stocks becomes greater than 20, then it becomes counterproductive for the portfolio. Although the risk decreases but the profit margin will also decrease. The impact of a single stock in the portfolio will be minimal.
Note: Here the number of stocks in a diversified portfolio is suggested for an investment over Rs 50,000. If you’re investing a lesser amount, then your stock portfolio can be different. Read more here: How To Invest Rs 10,000 In India for High Returns?
Diversification is a good method to safeguard your portfolio during a market correction or a bear market. All the stocks in your portfolio will not perform poorly at once and even the poor performance of few stocks will be canceled out with your good performing stocks.
However, the diversified portfolio does not act as a shield for your portfolio during a recession or market crash. During the 2008 market crash, when Sensex fell over 60%, then even the well-diversified portfolios weren’t able to safeguard the investor’s portfolio.
Other points to Note for Diversified Portfolio
Here are a few other points that you should also know while building a well-diversified stock portfolio:
— Rebalance your Portfolio Regularly: Sometimes, a few of your stocks might be performing extremely well and can become the major contributors to your portfolio. In such cases, rebalance your portfolio so that it can remain diversified.
— Hold the winners and Cut the losers: Do not hold the underperforming stock too long just to keep your portfolio diversified. Sell the losing stocks and re-organize your portfolio.
Ideally, a well-diversified portfolio should have 8-12 good stocks from different sectors/industries. The minimum number of stocks should be three and a maximum of 20 for the stock portfolio of a retail investor.
That’s all. I hope this post on How many stocks should you own for a diversified portfolio was useful to the readers. If you have any doubts regarding your portfolio, please comment below. Invest smart, invest long.