Last week, I glanced at my friend’s portfolio. It had 78 stocks in it. What's the big deal about 78 stocks?
Diversifying your stocks portfolio is a good idea because it decreases a number of risks, including non-systemic and company-specific hazards. But the problem is in over-diversification. And it also reduces your ability to generate higher returns.
Over-diversification lowers your returns while doing nothing to reduce your risk. Keep in mind that after you reach a certain number of stocks, the risk reduction benefit disappears, as do your expected returns.
It's a lot easier to track 15 to 20 high-quality stocks than a large basket of 50 to 100 stocks. It’s true that you shouldn't put all your eggs in one basket. But that doesn’t mean you should own all the eggs out there. Diversification is good, but too much of it can be bad. So, what's the final number?
The average diversified portfolio contains between 20 and 30 stocks. While there is no one-size-fits-all answer to this question, it is influenced by a variety of factors, including your investment horizon, risk tolerance, and current portfolio diversification.
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These are some stock-selection guidelines I follow to ensure a well-diversified portfolio without going overboard.
Rule #1: Do not go to every party in town
Want to put money into Tejas Networks because 5G is the future, or Tata Motors because of the electric vehicle story?
The trick is to learn how to invest in a company and sector that you understand, which might be either of these two or any of the other 4000 actively traded companies. Invest in the story you believe in, not the tale that social media experts believe in.
Rule #2: Put incremental savings in existing stocks
Invest your additional savings in your current portfolio itself. You don't need to go out and buy a new stock every month or whenever you have surplus money unless you already have a sizable investment in existing stocks. Design your portfolio with the future in mind; for example, if you want to build a portfolio worth Rs 1 crore, and your current portfolio is worth Rs 10 lakh distributed across
ICICI Bank, SBI, TCS, Infosys, Asian Paints, Tata Power, Reliance Industries, HUL, Bajaj Finance, D-Mart, HDFC, SBI Life Insurance and so on.
Thebestthingyoucandoiscontinuingputtingyourextramoneyintoyourexistingstockportfolio,whichistailoredtoyourrisk profileandfinancialobjectives. So, unless your current portfolio is under-diversified or you find an attractive stock to invest in, you can keep investing in your existing stocks.
Rule #3: You are not a mutual fund
It’s okay for mutual funds to hold 60-70 stocks. But you are not a mutual fund. It's nearly impossible for a retail investor to research and keep track of so many companies. It is also fashionable to claim that one has invested in Tata Motors, IRCTC, IEX, Tata Teleservices, Saregama India and such stocks that have been in the news of late, but the important question to ask is how much one has invested; if the allocation was less than 1 percent or 2 percent of one's total investments, there are hardly any gains despite these stocks' massive gains in the last year and a half.
Rule #4: Number of stocks have nothing to do with portfolio size
Many people believe that the amount of money you have to invest should determine how many stocks you buy. But diversifying your portfolio is important regardless of how much money you have to invest; if you had Rs 5 lakh to invest, holding 25 to 30 stocks would be too time-consuming.
Even if you have a huge stock portfolio, say more than Rs 1 crore, the number of shares you own should not exceed 20-25; you need to know that your time commands a value. Having too many stocks is fine only if you're an active investor or if investing is your business or career. If you have a job or a business to operate, then, investing in blue-chip companies along with a combination of ETFs and mutual funds is a superior option. In any event, there is no universally accepted solution, so one must carefully consider all of the advantages and disadvantages, as well as some of the arguments I've raised in this column.
Rule #5: Concentrate on sectors instead of numbers.
The number of stocks in a portfolio is irrelevant in itself. This isn't just about the number of stocks in your portfolio; it is about the quality of those stocks. The problem is resisting the urge to invest in too many stocks because you like companies in the same sector.
Take the banking industry for example: you may favour ICICI, Axis, HDFC Bank, Kotak Bank or government-owned banks such as SBI, Canara, or Bank of Baroda. But can you afford to invest in all of them? No, even if you can. You should be selective based on your research and convictions, and invest in no more than two or three stocks in a given industry, and a few stocks overall.
