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June 11, 2018

How Many Investments to Hold in Your Portfolio

The number of investments required to be adequately diversified depends on a few factors. For most individual investors, the number is not very high. It does depend on what is held in the portfolio and the dollar size of the portfolio overall. This week, I provide a few guidelines.

Let’s start with stocks. We suggest holding a minimum of 10 stocks to those following our Model Shadow Stock Portfolio or VMQ Stocks, 12 for those following AAII Dividend Investing (DI) and 16 for those following our Stock Superstars Report (SSR). The total number of stocks held in our portfolios are 20 for VMQ, 24 for DI, 31 for Shadow Stock and 36 for SSR.

Three of the four portfolios (VMQ Stocks, DI and SSR) have a fixed number of positions. The number of holdings in the Model Shadow Stock Portfolio can rise if a strong-performing stock is sold. This is because the proceeds from the sale will be split to fund two or potentially three purchases. With all of our model portfolios, a dollar amount equal to the average size of all existing holdings is allocated to new purchases. Using VMQ Stocks as an example, the portfolio was built by dividing the starting account balance of $100,000 evenly among 20 stocks. The target amount used to purchase replacements for stocks sold in the future will be the total portfolio value divided by 20, or 5% of the total portfolio. The AAII InvestoGraphic linked to below explains this concept further.

The reason why we do this is to prevent a disproportionately large position from becoming an even larger position. Having a single stock driving a portfolio’s returns is a double-edged sword. This same concept applies to the number of holdings. If you only hold, say, five stocks, then each stock has the potential to influence your portfolio’s value by 20%, including depleting it by 20% under a worst-case scenario. If you increase the allocation to 10 equally weighted positions, the biggest adverse impact any single stock can have is 10%.

I realize there is a school of thought about allocating based on your level of conviction. While I personally don’t see a benefit to going much over 30 stocks unless you are allocating a very large amount of money to stocks with lower levels of trading volume, I’m not keen on going in the other direction and holding just a handful of what you consider to be your best ideas. Doing so concentrates risk and exposes you to significant downside if you’re wrong. Plus, years of managing portfolios has taught me that the best- and worst-performing stocks in a diversified portfolio are often not the ones you would expect at the time you add stocks to the portfolio. Spreading your bets in a disciplined manner has benefits.

Bond positions can be more concentrated if you are focusing on high-credit-quality debentures. A bond ladder, for instance, can use Treasuries for maturity dates of two years, five years and 10 years. For corporate and municipal bond holdings, a mix of different issuers becomes more preferential to avoid any unexpected company/municipality-specific issues. When buying individual bonds, pricing and availability are also considerations.

Fund holdings (mutual or exchange-traded) can be the most concentrated. A single asset allocation fund (e.g., a target-date fund) can provide all of the needed allocation. A two-fund solution can also work, such as 60% allocated to an S&P 500 index fund and 40% allocated to a bond fund. Our Level3 Passive Portfolio holds just four ETFs. For those who want to include commodities, Craig Israelsen has a seven-asset portfolio. There are other examples, but the big point is that a small number of well-chosen funds can do the job.

The Week Ahead

Just two S&P 500 companies are scheduled to report: H&R Block Inc. (HRB) on Tuesday and Adobe Systems Inc. (ADBE) on Thursday.

The Federal Open Market Committee (FOMC) will hold a two-day meeting starting on Tuesday. The CME’s FedWatch Tool is placing a 91% chance of a quarter-point rate hike being announced. The meeting announcement and updated committee member forecasts will be released Wednesday at 2:00 p.m. Eastern Time. Federal Reserve Chairman Jerome “Jay” Powell will hold a press conference at 2:30 p.m.

The week’s first economic report will be the May Consumer Price Index (CPI), released on Tuesday. Wednesday will feature the May Producer Price Index (PPI). May import and export prices, April business inventories and May retail sales will be released on Thursday. Friday will feature the June Empire State Manufacturing Survey, May industrial production and capacity utilization and the University of Michigan’s preliminary June consumer sentiment survey.

The Treasury Department will auction $32 billion of three-year notes and $22 billion of 10-year notes on Monday, and $14 billion of 30-year bonds on Tuesday.

Courtesy of Charles Rotblut, CFA is the VP and Editor for American Association of Individual Investors (AAII). Charles is also the author of Better Good than Lucky. (EconMatters author archive here)   

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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