How many stocks should you own? What should be the weight of each stock in your portfolio? There is no right or wrong answer to this question. Professional fund managers can have concentrated portfolios consisting of very few stocks with large weights in each stock or can have diversified portfolios with large number of stocks with low weights in each stock. The performance of a smaller portfolio may not necessarily beat the performance of a large diversified portfolio.
Professional fund managers usually have many constraints given investment objectives, sector and issuer specific limits and regulatory restrictions. The constraints faced by professional fund managers do not apply to individual portfolios. Hence you can create your own portfolio of stocks within a broad framework that you have defined for yourself. You would have learnt to define a broad framework for your portfolio by following the “Learn to be Your Own Fund Manager Series”.
The number of stocks going into your portfolio should depend on your time and ability to maintain the portfolio. A large number of stocks in a portfolio will require that much more time to be spent on the portfolio. However it does not mean that you should have fewer stocks in your portfolio just because you do not have time to maintain a large portfolio.
A portfolio with few stocks requires deep analysis and conviction. The reason is that a seven stock portfolio will have high weights in a few stocks and if any one these stocks underperform, the portfolio performance will be affected. On the other hand a portfolio with 30 stocks will not suffer too much underperformance if one or two stocks underperform given that weights are not very high for the stocks.
Stocks and weights of stocks in your portfolio
The ideal number of stocks going into your portfolio should be between ten and twenty stocks. The reason that a ten to twenty stock portfolio is ideal for you is that the portfolio is manageable and concentration of weights will not be very high. The portfolio is also more likely to perform given that you would have had the time to do some work on the stocks and given that each stock has enough weight to ensure that your effort bears fruit.
The weight of each stock should be a minimum of 5%, as your work on the stock should be reflected in the stock’s weight in the portfolio. Strong convicting stocks can have much higher weights but not more than 20%. Stocks performance can go against your analysis for various reasons and if a highly weighted stock in your portfolio underperforms in the short term you may be tempted to reduce weights at the wrong time.
Individual weights to stocks should depend on factors such as future potential, valuations and balance sheet strength. The market environment should also play a part in stock weights. In an uncertain market environment, a fundamentally stock that is seen as expensive should have higher weights than a high growth but high risk stock. The latter can be deeply affected by uncertain macro economic conditions. On the other hand, in a bull market you can give high weights to high growth, leveraged stocks as such stocks will tend to outperform the fundamentally stock stocks that are showing growth but not at a hectic pace.
Build your stock portfolio with ten to twenty stocks depending on your confidence and time levels with weights reflecting your own views on each stock and reflecting the macro economic environment.