How Many Stocks Should You Own?
Ideal Portfolios Generally Consist of At Least 20 Stocks
How many stocks should be in your portfolio? This is a tricky question, but research suggests that a well-diversified portfolio should generally hold at least 20 stocks. However, this isn’t a hard and fast rule, and some research suggests that it may be safe to have somewhat fewer stocks, while others suggest that a much larger portfolio of 30-50 stocks is safer.
While it’s easy to throw out a specific number like 20 or 30, the number of stocks an investor should hold in a portfolio depends on the investor's individual goals, including risk tolerance, investment timelines, sector concentration, geographical concentration, position size, and other specific risk factors. Overall, quality should always come before quantity, and volatility is not the same as risk, so while larger stock portfolios may be less volatile, they may not be less risky in the long term.
In this article, we’ll review various research studies and discuss how the abovementioned factors may impact the results of holding different numbers of stocks. Ideally, this will help you determine the number of stocks you should keep in a portfolio, whether investing for yourself or others.
First Off: Why Hold Individual Stocks?
In the age of ETFs and passive investing, owning individual stocks has become unpopular, especially for individual investors. There are some excellent reasons for this, including:
Most active managers don’t beat the market, especially during extended periods of 5, 10, or 20 years.
Individual investors typically don’t have the proper knowledge and training to safely select individual stocks.
Individual and institutional investors often don’t have the disciplined mindset to choose high-quality, undervalued companies and hold them for the long term.
Determining when to sell stocks can be even more difficult than choosing when to buy them.
ETFs typically have significant tax advantages over individual stocks, mainly due to the tax implications of selling stocks that are considered overvalued or unlikely to perform well in the future, as well as the rebalancing required to ensure proper position sizing. This can lead to substantial capital gains tax burdens, reducing net returns after taxes.
Many would say that investors should only hold individual stocks if they believe they will beat the overall market (often using a benchmark like the S&P 500). However, this isn’t true in all scenarios and depends on the investor’s or client's goals.
A more sophisticated way to look at whether actively buying and selling individual stocks would be to look at the long-term capture ratio of a stock portfolio. This can be determined by taking the portfolio’s upside capture and dividing it by the downside capture.
Upside Capture: The return of a portfolio compared to a specific benchmark (like the S&P 500) during up-markets. If a portfolio returned 10% and the S&P 500 returned 10%, the portfolio would have an upside capture of 100%.
Downside Capture: The return of a portfolio compared to a specific benchmark (like the S&P 500) during down-markets. If a portfolio lost 10% and the S&P 500 lost 10%, the portfolio would have a downside capture of 100%.
Capture Ratio: The upside capture divided by the downside capture. Using the examples above, 100%/100% = 1.0. A capture ratio of 1.0 matches the benchmark. There is no point in actively managing individual stocks unless an investor or manager can achieve a capture ratio of more than 1.0. A capture ratio of above 1.0 means that the investor achieves a better risk-to-reward ratio than the market benchmark.
For example, for a conservative investor, if a portfolio goes up 80% of the benchmark when the market is up and falls only 50% against the benchmark when it is down, the capture ratio would be 1.6, indicating a better risk-to-reward ratio than the benchmark.
For a more aggressive investor, if a portfolio goes up 100% of the benchmark when the market is up and falls only 70% against the benchmark when the market is down, the capture ratio would be 1.42, indicating a better risk-to-reward ratio than the benchmark.
For the most aggressive investors, who may be willing to tolerate higher-than-market losses for higher-than-market rewards, if a portfolio goes up 150% against the benchmark when the market is up and falls 110% against the benchmark when the market is down, the capture ratio would be 1.36, also indicating a better risk-to-reward ratio than the benchmark.
So, How Many Stocks?
While most experts believe that 20-30 stocks provide sufficient diversification and reasonable returns, we’ll explain some arguments for having various ranges of stocks in an investment portfolio below:
Fewer Than Ten
Very few investors and investment experts suggest that a portfolio of fewer than ten stocks provides sufficient diversification and risk-adjusted returns that beat-- or even come close to market indexes like the S&P 500. Despite this, some of the very best investors invest in only a few stocks and sometimes beat the market by doing so. Warren Buffet once said that a portfolio of six stocks, diversified across multiple industries, is enough to provide excellent returns-- as evidenced by his statement that “very few people get rich on their seventh best idea.”
As of September 2024, Warren Buffet held 45 stocks in his portfolio (as of his last 13F filing)-- so he isn’t exactly practicing what he’s preaching. However, the vast percentage of his portfolio is only in a few holdings, with more than 78% comprising just six stocks, with Apple representing his largest holding at just over 30%.
Despite this, it’s essential to appreciate that while Buffet’s stock portfolio is currently valued at an estimated $279 billion, most of Berkshire Hathway’s value rests on companies that it privately owns, like Geico and Dairy Queen, so while a 30%+ allocation in Apple stock may seem enormous, the market cap of Berkshire is currently around $1 trillion. Hence, his stake in Apple, which is currently valued at around $86 billion, is only equivalent to around 8.6% of the company's market cap.
Despite Buffet’s advice, most investors and even expert wealth managers don’t come to have the genius stock-picking abilities of Warren Buffet, so Buffet’s methods represent the exception rather than the rule-- and therefore, having so much of a portfolio in so few companies may be a terrible idea for most investors.
Ten Stocks
One of the first studies that looked at the amount of stocks needed to generate the average market return was a 1968 study by John Evans and Stephen Archer, “Diversification and the Reduction of Dispersion: An Empirical Analysis.” This suggests that only ten stocks are enough to replicate or beat the return of the entire stock market. However, this study is now more than 50 years old, so it’s possible that changes in the market could render this information inaccurate.
In particular, research suggests that stocks have become more volatile over the last few decades, with one 2000 research paper co-authored by Burton G. Malkiel, the famed author of A Random Walk Down Wall Street, indicating that from 1962 to 1997, the volatility of individual stocks has increased significantly compared to the market as a whole. This could result from various factors, such as the rise of potentially more volatile tech stocks during the dot-com boom, the increased influence of hedge funds and other “whales” in the marketplace, and other phenomenon.
Twenty Stocks
Other investment researchers suggest that a portfolio of twenty stocks is closer to ideal when constructing a well-balanced portfolio. In their book Modern Portfolio Theory and Investment Analysis, Edwin J. Elton and Martin J. Gruber state that a single stock's average standard deviation (a potentially good measure of risk) was 49.2%, and the average standard deviation of a 20-stock portfolio was 22%. However, the average standard deviation of a 1,000-stock portfolio was 19.2%, meaning that while adding the first 19 stocks significantly limited investment volatility via a reduced standard deviation of 27.2%, adding the following 980 stocks only reduced the standard deviation by an additional 2.8%, which isn’t much.
Thirty Stocks
In another research paper, researcher Meir Statman stated that investors should own at least 30 stocks, contradicting Evans and Archer’s previous research that ten stocks were sufficient for adequate diversification and risk management.
Fifty or More Stocks
Very few investment professionals recommend owning fifty or more individual stocks, as your chances of obtaining a higher risk-adjusted return are diluted by owning so many companies (we’ll go more into over-diversification later). Most active mutual fund managers do this; very few beat the market (or even provide a reasonable risk-adjusted return) over the long run. Therefore, if you feel diversification is so important that you need to own fifty or more stocks, you’d probably be better off investing in an ETF or mutual fund that tracks a broad market index like the S&P 500.
The Problem With The Above Investment Research Studies
While each of the above arguments may have some merit, and many researchers have looked closely at how many stocks are required to achieve a certain level of volatility or investment return, many of the research papers mentioned have significant issues that should be mentioned. The primary problem is that most of these studies have randomly selected stocks from the S&P 500 or large baskets of 1,000+ stocks. Therefore, unlike most successful investors, they did not use specific investment criteria when choosing the stocks.
This likely means they could be overestimating the number of stocks required to achieve a volatility level or investment return similar to the broader market. This is because, ideally, a decently diversified portfolio of quality companies purchased at reasonable prices (even if it contains relatively few stocks) will provide a higher level of reward-to-risk than the broader market itself.
Remember, Volatility is Not Risk
While owning individual stocks isn’t for everyone-- and often isn’t a good idea unless one is either an investment professional or an obsessed researcher, those committed to owning individual stocks should not necessarily over-diversify and select too many stocks by confusing volatility with risk. Volatility is simply the range of price change during a specific period, while risk is generally defined as the permanent loss of capital.
For example, if the value of a stock portfolio experienced an average maximum drawdown of 20% or more per year, but if the ten-year return of that stock portfolio significantly beat the market-- say, by returning an average of 15% or more per year, that portfolio might have very high volatility, but it might not be high-risk. Of course, high-volatility portfolios (even if they have good long-term returns) can cause significant stress to investors (possibly causing them to panic and sell stocks early). In addition, these types of highly volatile portfolios may not be suitable for many individual investors, particularly retirees who are drawing down on their stock portfolios for living expenses.
This is mainly due to the sequence of returns risk-- the risk of significant losses occurring in early retirement (or even the years before retirement). For example, suppose an investor is drawing down 4% of their portfolio’s value each year-- and that portfolio drops by 20% for an extended period. In that case, their losses are compounded (as they are now drawing down on a significantly smaller portfolio), and this can lead to permanent loss of capital.
Combining Stocks and Index Funds
It may provide sufficient diversification and reasonable returns if an investor holds 1, 5, or 10 individual stocks in a portfolio combined with broad-based market index funds that track indices like the S&P 500, provided the position size of one particular stock isn’t particularly large. For example, if an investor held only five stocks, each consisting of 5% of their stock portfolio (25%), and held the rest of their stock allocation in an S&P 500 ETF (75%), they would still have exposure to 500-505 stocks (depending on whether the individual stocks were also in the S&P 500).
However, if the stocks an investor holds have huge market caps, they will suffer from significant overlap or replication, increasing the weight of that stock in the investor’s portfolio. For example, as of September 2024, Apple, with a market cap of $3.29 trillion, already represents 7.01% of the S&P 500, so holding 5% of your portfolio in Apple and 75% in an S&P 500 index fund would give you a 10.26% exposure to Apple, which may be undesirable.
We can calculate this by taking the 7.01% market cap of Apple and multiplying it by the investor’s share of Apple in their S&P 500 ETF holding (making that 5.25% of the portfolio) and adding their 5% individual holding in Apple (5.25% + 5% = 10.26%).
In contrast, investing 5% of your stock portfolio in Google, which is currently only 1.75% of the S&P 500, and investing 75% of your portfolio in an S&P 500 index fund would only give you a 6.31% exposure to Google (1.75% * 0.75% = 1.31% + 5% = 6.31%), which may not be so unreasonable.
In addition, those investing in only a few stocks may also find themselves overweight in a specific sector, posing additional risks. In the above example, if 3 of the 5 individual stocks chosen were tech stocks (15% of the portfolio), about 40.2% of the investor’s portfolio would be in tech stocks.
This can be calculated by taking the current tech sector weighting of the S&P 500 (32.2%), multiplying it by their 75% S&P 500 exposure (25.2%), and adding the 15% additional allocation to individual technology stocks. This is why investors should also consider sector allocation when combining individual stocks with index funds.
The Dangers of Overdiversification
Holding more stocks in a portfolio may reduce volatility and reduce the risk of long-term loss of capital, but there is also the risk of overdiversification. This risk is generally behavioral and comes in two primary forms: 1) the chance of choosing lower-quality investments due to the desire to reach an artificially chosen number of stocks in a portfolio, and 2) the quantity and quality of research required to maintain a portfolio with a large number of stocks.
Regarding the second risk, it’s difficult enough for expert analysts and investment managers to choose excellent companies to invest in-- and many pros take months or even years of research before actually purchasing shares in a company. Therefore, it can be challenging for individual investors and even many fund managers to keep up with a portfolio of more than 25 stocks.
From initially researching the company to determining the correct price to buy and sell a stock, as well as keeping regular tabs on changes in a company that could be a sell signal (such as changes in broad economic trends or the selection of a lower-quality or inexperienced CEO), an individual investor an even an expert manager could find themselves spending 100 hours a week on research alone-- and that isn’t realistic for the vast majority of people.
Factors to Consider When Constructing an Individual Stock Portfolio
Below, we will review some of the essential considerations when choosing a portfolio of individual stocks:
Sector Diversification
The risk of a portfolio isn’t only determined by the number of stocks an investor holds but also by the percentage of stocks they own in any one sector. For example, an investor could hold an equal-weighted portfolio of 200 stocks, but if 100 are energy stocks, the portfolio could face significant losses if energy prices fall, new energy sources are discovered or developed, or other issues negatively impact the energy industry.
There is no hard and fast rule regarding sector allocations, but holding more than 20-25% of stocks in a single sector can be risky. It may also be helpful to look at the sector allocation of the market as a whole.
For example, as of September 2024, real estate stocks represent slightly more than 2% of the S&P 500. If an investor were to hold 15% of their portfolio in real estate stocks, that sector’s allocation would be far higher than that of the market itself, which could (possibly) be risky. Of course, if the investor correctly judges that real estate stocks provide a higher risk-to-reward ratio than other market sectors, this wouldn’t be the case, but this would be a big bet to take.
It’s also important to consider that the current market may be overweight in specific sectors. For example, as of September 2024, more than 32% of the S&P 500’s market cap comprises technology stocks. This is around 20% more than the second largest sector, financial services, which, as of September 2024, consisted of just under 13% of the index’s market cap.
Many believe that some of the largest stocks in the tech sector, like NVIDIA, are significantly overvalued due to the overall market’s conviction that AI will massively increase the profitability of the tech sector, so an investor looking to create a balanced portfolio might wish to cut their technology holdings to 20-25% of their portfolio.
However, your sector allocation should also depend on your risk tolerance and willingness to experience extended drawdowns for the potential of higher long-term returns. In general, sectors like healthcare/pharmaceuticals and consumer staples are considered more “defensive,” meaning they have lower growth potential but also lower risks.
In contrast, other sectors, like technology and consumer discretionary products, are considered more “offensive,” meaning they may provide potentially high returns at the cost of higher risk. Some sectors, like energy, are considered “defensive” by some and “offensive” by others. Yet others would say that the energy sector is relatively uncorrelated to the broader stock market (at least as far as sectors go), as stock prices fluctuate due to commodity prices and geopolitical risk.
In the author’s opinion, historical price data would suggest that energy is more defensive than offensive, as it performed well during 2000-2010, a period when the U.S. stock market faced two devastating market crashes, as well as during the stock market crash of 2022, when energy prices spiked, mainly as a result of the Russia-Ukraine War. To illustrate, today’s ten largest energy stocks by market cap returned a CAGR of 16.15% from 2000-2010 vs. the 0.32% CAGR of the S&P 500 (as measured by Vanguard 500 Index Fund Investor Shares). In addition, these ten energy stocks returned a massive 50.93% CAGR in 2022, when the broader S&P fell more than 18%.*
*The author should note that by choosing the largest energy stocks by market cap today rather than in 2000, the 2000-2010 sector analysis may suffer from hindsight bias.
Position Sizing
Position sizing, or the percentage size of a single stock in an investor’s portfolio, is another aspect to consider when constructing a portfolio of individual stocks.
If a position grows too big, it could represent an undue risk to the investor. Conversely, if a stock has fallen and the position is now smaller, but the investor believes it is undervalued and has excellent growth potential, they may want to increase that holding.
For example, even a portfolio of 100 stocks may not be appropriately diversified if the largest three holdings represent 30%, 20%, and 10% of the investor’s portfolio (60% total), and the remaining 97 stocks each represent only a fraction of the percentage of the portfolio. It may make sense to weigh each stock in a portfolio equally; for example, a portfolio of 25 stocks might have each stock consisting of 4% of its total holdings.
However, many investors might recommend deciding on position size more on your conviction that it’s an excellent investment rather than weighing each stock equally. Investment experts differ on the appropriate maximum position size, and, in general, if an investor has more expertise (and hence potentially more conviction in their stock selection), they may be willing to use larger position sizes (such as Warren Buffet’s aforementioned 30%+ weighting in Apple).
Finally, it’s essential to consider that most investors, unless they are professionals managing equity-only funds or very young people, hold stocks and bonds in their portfolios. This can impact position sizing. For example, an investor with a lower percentage of stocks in their portfolio may get away with having fewer stocks while experiencing the same level of overall volatility and loss risk as an investor with a higher stock allocation who owns more stocks. This is because certain bonds, like U.S. Treasuries, present very little risk to the investor.
For example, a research report published by investment advisory firm Edward Jones suggests that an investor with a 25% stock allocation should hold 15 stocks, an investor with a 25-50% stock allocation should own 15-20 stocks, and an investor with a 50% or higher stock allocation should own 25-30 stocks. This is very general advice and does not consider many other factors, such as company selection and risk tolerance. However, it does provide a decent template that some may wish to follow.
Portfolio Rebalancing
When considering position sizing and diversification, portfolio rebalancing is also essential. Portfolio rebalancing can be done in a variety of ways. The simplest way is to rebalance each year based on the initial size. For instance, if your initial position in Berkshire Hathway was 7%, and it grew 28% to 9% at the end of a one-year period, you would sell 28% of your Berkshire stock to shave your position back to 7%. This method also ensures that you maintain the same sector weighting so that an investor is not overexposed (or underexposed) to a specific industry.
However, this simple method does not consider each stock's individual benefits and risks, so while doing things this way may be the easiest and can help ensure an investor is not overweight in any one company or sector, it may not generate optimal returns. Many investors believe in “letting your winners win” and, therefore, will be hesitant to shave off positions in fast-growing stocks if they think they still have significant growth potential (and, ideally, remain undervalued or at least fairly valued).
In addition, rebalancing your portfolio will have significant tax implications. For instance, if your capital gains tax rate is 20%, and, following the example above, you sold 28% of your Berkshire stock, your net annual gain on the investment would fall to 22.4%. Individual investors who utilize tax-deferred retirement accounts like IRAs or 401(k)s may not have to worry about this. However, professional investors and individual investors who use taxable brokerage accounts can face hefty tax bills from rebalancing.
Overlapping Risk Factors
There are hundreds of risk factors that can impact long-term stock prices, including interest-rate risk, management risk, country risk, and inflation risk, just to name a few. Risk can never be eliminated, but it's always important to consider the various risks of each company when investing. The more in-depth research you do on a company, an industry, and a company’s competitors, the more you may be able to minimize potential investment losses. However, in a broader sense, when building a stock portfolio, you want to be most aware of overlapping risk factors-- i.e., factors that can impact a substantial number of companies in your portfolio.
Of course, some of this can be mitigated by ensuring you’re not overweight in any one sector, but many other factors must be considered. For example, if many companies in your portfolio have significant debt that needs to be refinanced soon (such as short-term bonds), a spike in interest rates could lead to considerable portfolio losses. Likewise, if many companies in your portfolio have significant operations in higher-risk countries or regions like China, South America, or Africa, geopolitical instability, changes in currency exchange rates, or changes in government policies could also lead to significant losses.
These risks can not necessarily be mitigated by holding many stocks or through adequate sector diversification. However, they can be mitigated by doing significant research before buying a stock.
Base The Number of Stocks You Own On Your Own Investing Goals
In the end, there is no magic number of stocks in a portfolio that can generate the highest returns with the lowest risk. As long as you hold a reasonable number of stocks (“reasonable” being quite hard to quantify), quality, value, and growth potential should generally come before hitting a magic number.
Unless you’re already a Wall Street pro (and, if you are, you probably aren’t reading this article), holding less than 12-15 stocks can be risky and lead to significant volatility. However, owning 12-15 outstanding companies, purchased at the right price, is often far better than owning 20, 30, or 50 mediocre businesses.
Smaller portfolios and larger position sizes are generally best for experienced investors willing to tolerate more volatility and longer-term drawdowns. In contrast, slightly larger portfolios with smaller position sizes may be best for somewhat less experienced investors who desire lower volatility. However, investors should never choose more stocks than they can adequately research and regularly analyze.
You should always base your purchases and position size on your conviction in the success of an individual company, not on reaching a pre-set number, while also keeping in mind factors like sector diversification and overlapping risk factors.
Remember, if your conviction in an individual stock is not extremely high-- just don’t buy it. You can always invest in index funds, which is usually the best way for most individual investors who can’t dedicate a lot of time to researching individual companies.
If you treat your stock investments like a hobby, not a business, your long-term risk-adjusted returns will likely be poor-- making you regret that you didn’t just invest in index funds and leave individual stock picking to the pros. And, if you can only find one, two, or three companies that you truly believe will have a better risk-adjusted return than an index like the S&P 500, you can always combine individual stocks and index funds-- but, when investing in mega-cap stocks, remain aware of stock duplication that could leave you overweight in a single company or sector.
