Thinking about whether you hold too many or too few stocks and funds
Thursday 25 Nov 2021 Author: Laith Khalaf

Diversification is a universally agreed principle of portfolio management, for both professional and DIY investors. However, there’s less consensus when it comes to achieving this in practice and also answering one of the key questions investors often ask about allocating their money: what’s the magic number for how many funds or shares they should hold in a portfolio.

The truth is there isn’t one number that can be picked out of the air that applies to all investors, but there are some guidelines which can help you determine what diversification looks like for your own investments.

WHAT TO THINK ABOUT WITH STOCKS

Let’s start by considering a portfolio of individual stocks. You certainly don’t want to put all your eggs in one basket here, because if that basket turns out to be Carillion or Patisserie Valerie, companies that ultimately ended up worthless for shareholders, you will have lost all your money.

Less dramatically, that one holding could just be a serial poor performer. In either case holding just one stock runs the risk of seriously damaging your overall wealth. But there are over 600 stocks in the FTSE All-Share index, with thousands in the global stock market, and it’s neither feasible nor desirable to hold all of them.

Investors can take a leaf out of professional fund managers’ books. A typical actively managed fund will hold between 50 and 100 stocks in it.

Managers who run highly concentrated portfolios like Nick Train and Terry Smith (pictured) get down to 25 to 30 stocks, which should be seen as a bare minimum for DIY investors.

That probably still sounds like a lot of companies to research and monitor, unless it’s your day job, but there is a little trick you can use to reduce that number, which I’ll come back to in a bit.

WHAT ABOUT FUNDS?

First let’s move away from investing in individual stocks and consider how many funds and trusts should be held in a portfolio.

Each fund or trust is already a diversified pool of stocks, so you might think you only have to hold one. That may well be true for plain vanilla passive fund investors. A typical global index tracker fund will invest in around 1,500 stocks, so that ticks the  box nicely.

If you invest in active funds, by choosing only one fund you may well diversify away the negative effects of one company in the portfolio failing or floundering.

But you would still have the risk that the fund manager underperforms, and that risk is higher the more concentrated the manager’s own approach to investing.

A portfolio of between five and 10 active funds should prevent one fund manager’s underperformance unduly affecting your wealth, or seriously derailing your retirement plans.

Investors may choose to add more if they feel up to keeping on top of a larger number of investments. If you think five to 10 funds is still too many to manage, there’s that little trick I mentioned, which can help in this instance too.

CLEVER TRICK

The trick is to use index trackers as a building block at the core of your portfolio, so you don’t have to worry too much about diversification in your other holdings.

Because index tracker funds invest in the whole market, by holding a decent chunk of your portfolio in these funds, you will be well diversified enough to avoid any problems arising from the underperformance of a single company or fund manager.

For instance, if you held 80% of your portfolio in a global tracker fund like Fidelity Index World (BJS8SJ3), you could then invest the remaining 20% in five stocks that you like, without opening yourself up to too much company specific risk. Or if you’re a fund investor, you could invest the 20% of your portfolio in one or two active funds.

DOWNSIDES TO CONSIDER

By spreading your eggs across numerous baskets, you also reduce the positive impact an investment that performs exceptionally well can have on your total wealth, compared to if you had all your portfolio in that one asset.

Unless you are investing with perfect hindsight though, you’re not going to know which investments are going to   perform best.

No matter how high your conviction in an individual fund manager or company, as an investor you should always ask the question – what if I’m wrong? That’s precisely where diversification comes in, allowing you to invest with confidence, even if you don’t have a crystal ball.

DISCLAIMER: Daniel Coatsworth who edited this article has a personal investment in Fidelity Index World

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