The answer to this question depends on who you’re talking to, of course. One author spouting ETF’s shows how, if you want to keep things really basic, you only need three ETF’s if they’re well chosen. A bond ETF, an S&P composite ETF, and some foreign ETF. Jim Cramer doesn’t do ETFs, he’s just into buying stocks directly – not DRIPPING, but just going through your seven-dollar-a-trade-broker and purchasing yourself. Cramer caps his own portfolios at 25 stocks. He says you need a minimum of 5 to be fully diversified, and that you need to spend an hour each week doing homework on that stock. So for most people, that limits their portfolios to about 10 stocks.
I disagree that you need to do that much homework each week on each stock. I agree that the quality and type of homework he recommends needs to be done, however. But for any given stock I don’t think you need to do that each week if you’re buying and holding.
Back to diversification, though. How much do you think is enough? I’ve only been in the investing game for a decade, but I can already tell I’m a pretty contrarian investor. I think alot of people like to think they’re contrarian investors, though. I can tell you I have more than Cramer’s 25 stocks, though! And I don’t think it’s too much. I’ll buy what I like. There are more than 5 sectors and there is more than one country on the planet. It’s good to spread your wings. Here’s my own recommendations for diversification:
I’d recommend at least 20 stocks for real diversification
- two oil stocks
- one oil-and-gas-industry related stock, like transportation or info services
- two financial stocks (banks)
- one insurance stock
- two foods stocks (big grocer plus a supplier, maybe)
- one healthcare stock
- two mining/resources stocks
- two transportation stocks (railways, trucking fleets)
- four foreign stocks (in a sufficiently different market correlation from the U.S.)
- one auto-manufacturer (that is already a leader and will be expanding into fuel-cell and hybrids etc.)
- two utilities (one local, one national)
- one telecommunications stock
I could go on and on. I don’t think 5 stocks are really enough, even if you are in 5 different sectors. You’d split up 20% to everything and if that one company does poorly, that’s 20% of your portfolio. (If you’re in ETFs, that’s different. 5 ETFs could be enough if you can sit well with a 100% ETF strategy.) At 10 stocks, you’d still have 10% on just one company, and that goes contrary to many recommendations about only keeping maximum 5% in one company. For that, you’d need 20 stocks.
I don’t always plop down a big amount on each new stock acquisition. Sometimes it’s rather low and makes the commission look horrendous. Right now, that doesn’t bother me. I’d rather know I’m well-diversified.
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{ 6 comments }
Everytime I try to trade a portfolio of less than 10 stocks, I get mixed results. Five Etf’s would be better than trading five stocks because you get diversification in the Etf.
However, I prefer to have a 10 stock portfolio because each stock is worth 10% of your portfolio and if one stock drops 50% (has happened to me), your port will drop 5% (though disturbing, but better than a 10% drop if you have a 5 stock portfolio).
That’s a good way of looking at it. So for some people, 10 stocks might be a good benchmark to start with – it certainly keeps the math easy. So with 20 stocks, each stock is worth only 5% of your portfolio (assuming equal amounts in each) and if it drops 50%, your portfolio would be down about only 2.5% (assuming your other stocks stayed flat, of course, which they rarely do).
So one of the worst-case scenarios with a 20-stock portfolio is that if one stock totally crashes, at most you lost 5% of the whole portfolio. You can see, then, that even if you own 100 stocks, at most you’re in for a total crash-loss of 1%.
Always a better and safe idea to have
many stocks in a portfolio even if it means
about $500 in each stock.Diversification
is the most important thing nowadays.
Does your ‘foreign’ category refer to companies whose business is relatively unaffected by our economy here in the states?
Do your other categories have to be US companies, or can they be international companies who have large global exposures? Just wanted to double check, as buying a US automaker over Honda or Toyota just because they are ‘foreign’ seems foolish (unless you plan on a HUGE turnaround).
Just want to make sure I’m reading this right. :D
Good questions, Blake… I didn’t specify that enough. I was unconsciously assuming that the majority of those stocks would be North American (most of my readers are North American), and that foreign would mean largely, wholly, operating outside the U.S. and Canada. But it’s a good point because many U.S. companies are quite multi-national and as far as diversification is concerned, could be treated as foreign content. So it’s up to the individual to balance this out. I think I would want to make sure that I had at least a good third of my portfolio in foreign content, however that is derived.
Yeah, there are a lot of ways to look at foreign investments, but as long as your picking smart investments and not putting too much of your money in any one area, you should be fine.
Thanks for clarifying.
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