How many stocks should you have in your portfolio: You are beginning your investment journey. You have decided to create wealth for yourself and be your best.
The universe of investing is really huge, and you want to know what is the right size in terms of the number of stocks in your portfolio.
In reality, there is no absolute number, but the key point of creating a portfolio is actually to minimize the risk in the short term and maximize the returns in the long run.
Protecting your capital is important. It’s a no-brainer that we should all diversify our investments. We’ve all heard the term “don’t put all your eggs in one basket.”
How many stocks should you have in your portfolio – Risks Associated
To understand how many stocks should you have in your portfolio, you need to understand something – the risk associated with investing in general and ways to reduce the investment risks. There are two types of risk –
1. Systematic Risk
This is the economy’s absolute risk; it cannot be diversified; these risks are influenced by multiple variables such as inflation, interest rates, political instability, and, as we have seen, the covid-19 pandemic.
This is a risk that no individual or company can control; it can be avoided by hedging with multiple instruments.
Example – When the stock market as a whole falls, the price of gold rises because it is considered a safe asset, so the general idea is that if we own gold in our portfolio, we will face fewer losses in a bad event.
2. Unsystematic Risk
This is the risk associated with specific things; specific risk arises from the uncertainty of a specific firm or industry; this risk is diversifiable, and investors are frequently rewarded for taking it.
While buying stocks for a portfolio, we should aim to eliminate the Unsystematic risk, which is by holding different companies’ stocks in different industries.
Diversifying too much is also a problem because it erodes the performance of the overall portfolio. Having a lot of investments requires a lot of follow-ups and it can be hard to track too many investments.
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How many stocks should you have in your portfolio – Types of Portfolios
To tackle this problem of not diversifying at all or diversifying too much, we could create three types of portfolios, which are –
1. Long-term Portfolio
The idea of a long-term portfolio is to hold it for more than 7+ years. A long-term portfolio should consist of 12 to 15 companies.
These companies should ideally be very safe and fundamentally good companies that will grow and stay in the industry for a long time.
The parameters for considering companies in this category are great company fundamentals, good industry coverage, and overall management performance. This portfolio is subjected to minimal changes.
2. Medium-term Portfolio
The idea behind this portfolio is that we allocate our investments to booming and upcoming sectors. The ideal duration for a medium-term portfolio is between 2 to 4 years.
We should have 5 to 6 stocks in this portfolio. These stocks can be a little risky where we can invest in mid-cap and small-cap companies.
The other thing we can do in this type of portfolio is we can move our investments with respect to business cycles.
3. Short-term Portfolio
In this, we hold the stocks for up to 2 years, and we should have 1 or 2 stocks in this portfolio, these investments are considered swing trades, they come on the highest risk spectrum on the portfolio.
The construction of a portfolio is subjective and it is different for each individual. The tolerance to risk, the return expectation, and the time horizon for the investment are to be considered while planning the portfolio.
The risk of the industry and the risk of the individual stock are considered as a basis for allocating the stocks in the portfolio when building the portfolio.
The need for diversification becomes less when we are very sure of the information and the research, and this comes through education and experience in the stock market.
While diversifying, there are some generalized thumb rules which should be considered.
● Not investing more than 10% of the portfolio in one stock.
● Not Investing more than 20% of the portfolio in one sector or industry. ● Investing 10% of the portfolio in a safe haven (e.g., gold).
● Invest in ETFs or any index fund.
● Change asset allocation with respect to our risk tolerances.
There is no definite answer to the question of how many stocks should you have in your portfolio, but when it comes to diversifying a portfolio, we should take certain steps.
Understanding the types of risks involved will help us choose the right type of stock. Over-diversification reduces portfolio return.
Instead, create three types of portfolios for the long, medium, and short term; consider these four factors: capital, risk, expected return, and time horizon; this will help us outline what we want.
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