This is a subject that seems to crop up on Twitter discussions at least once a week. I figured that if I do a detailed Blog on the issues, then I can send out a link every time someone asks me the same question as I have responded to 300 times before !!
Don’t take that seriously. I am always very willing to take questions from people and it actually helps everybody because lots of ideas and approaches come out in our discussions and many, many Readers and Twitter People have exactly the same issues. So please keep the questions coming and I promise I will not just send you a link to this Blog !!
I scribbled out a Plan on A4 Paper with regard to what I need to cover in this Blog, but to be honest I am not totally sure how to structure it. I think in very simple terms I will go through a list of the Factors to Consider when deciding on how many Stocks to hold and then I will do a sort of Conclusion which has suggested numbers of Stocks for people of varying needs. That probably makes no sense at the moment, but hopefully it will all come out ok by the time we all reach the end of this Blog.
Factors to Consider when making the ‘Number of Positions’ decision
Time Available – this is a key consideration for probably about 98% of the people who are reading this Blog (assuming you have got this far and not given up already !!). The vast majority will have demanding Full Time Jobs and probably have busy lives outside of work with Families and Hobbies (ok, this probably means ferrying Kids to their Hobbies !!), etc. It’s not a leap of great genius to realise that when time is very limited, you need to focus on a smaller Number of Stocks and you need to have a Portfolio which you can leave on ‘Autopilot’ and largely ignore for much of the time. In reality, you might only get the chance to attend to your Portfolio once a Week or so. There is no problem with this, but you will have poor Results if you have limited time but try to run a Portfolio with 60 Stocks in it. Maybe 30 is the Maximum you should hold. Be realistic – don’t chomp off more than you can munch and all that. Unfortunately the 2 aspects of Time and Durability are often in conflict as a Small Focused Portfolio will not allow the Diversification you need to enable your Portfolio to weather difficult Market Conditions and fly on the Automatic Pilot.
Need for Liquidity – if you are a Full Time Investor or in some way rely on part of your Income for Living Expenses from your Portfolio, you must never get yourself into a situation where you are a Forced Seller. You should never Sell a Stock because you need money to go shopping in Tesco or something – Sell Decisions should only be because a Stock is Overvalued, or you have a better Stock you want to Buy or perhaps because Shorters are targeting it etc. In other words, you should only Sell Stocks because of their own Idiosyncratic reasons – not because you need Cash for a Holiday or something. Holding more Stocks gives you the ability to Sell things at appropriate times and perhaps withdraw Cash when you need to for Living Expenses – I do this quite often, but part of my idea of an Income Portfolio is to get more of my Living Expenses Cash from Dividends paid out by Companies – so I don’t need to Sell Stocks at the wrong time. If you only hold a low number of Stocks and you tend to Invest in Small Companies – you could find yourself very limited with your options when you need to raise Cash and you may have to Sell at inopportune times and at Worse Prices than you could get if you were able to wait. With Small Stocks, you really do need to ‘Sell into Rallies’ or as I think Leon Boros (@boros10 on Tweetster) says “Feed the Ducks while they are Quacking”. If you can trade at or near to Normal Market Size (NMS), then you can usually get pretty good Prices for Buying and Selling. However, if you deal in larger Sizes, then Prices are often worse. You many find by holding more Stocks this problem is reduced as you will be trading nearer to NMS on most Stocks. Any such problems of poor Prices due to a drying up of Liquidity are greatly exacerbated in Bear Market Panics – you really do not want to be a Forced Seller at these times.
Level of Interest / Passion for Stocks – I am defo guilty of this one – part of the reason my Portfolio has so many Stocks (probably about 58 at the time of writing, although I aim to drop it down to about 52 plus my Unit Trusts), is because I actually enjoy messing about with Stocks and the Stockmarket. It started out as somewhere to shove my Money back in about 1999 and quickly evolved into a Hobby (many would say an Obsession – probably a fair comment). Remember I am also a Full Time Investor – so I have the luxury of Time to give my Stocks the attention they need. If you don’t really enjoy doing Stocks (and lack time), then it makes sense to hold enough Stocks to keep things simple and mechanical and focused solely on the business of making Money. Perhaps 20 Stocks would be about the right kind of number here – you must have Diversification in your Portfolio. However, if you feel like this, maybe just Investing via Funds is the way to go – please see my ‘Funds’ Page on www.wheeliedealer2.weebly.com. The thing to realise here is that certain types of Portfolios need very little maintenance and you don’t need to do much. If you construct a Portfolio out of Funds to a large extent it should be ‘Buy and Forget about it’ – with perhaps just 6-monthly reviews. An Income Portfolio along the lines of the one I run (please see my ‘Trades / Portfolios’ webpage) is very low maintenance and I rarely look at it. As an aside, if you really don’t have much ‘passion’ for Stocks, then maybe there is little point you investing in individual Companies because you may struggle to get good Results if you are not really committed to it.
Use of Leverage – I use a lot of Leverage via Spreadbets and it is a vital part of my Approach (please see my ‘M3 Manifesto’ Page on this Website). It is not safe to use Leverage if you run a small and highly correlated Portfolio – you need a Large Portfolio with a lot of in-built Diversification to ensure a certain amount of ‘Natural Hedging’, where Stocks that are Up in the Portfolio offset those that Fall. This is vital in Market Pullbacks where this Natural Hedging effect will save you from a lot of pain. A small Portfolio with highly correlated Stocks (they all Fall and Rise together) will be extremely bad news in Down Markets. Please see my Blogs on Spreadbetting to understand this in more detail and the Dangers involved in messing about with Spreadbets and Leveraged Products if you do not really understand what you are up to (click the Category ‘Spreadbetting’ to find them on my Blog Page.)
Mix of Portfolios – part of the reason I hold so many Stocks is because I have several ‘Compartments’ for them. For example, I hold Big Dividend paying Stocks in my Income Portfolio and I have 11 Stocks there at the moment and I intend to add one more. In time, I may decide to push this up to 15 Stocks – the Jury is out. I then have 5 Unit Trusts – which actually give me exposure to hundreds of Stocks between them and then I have my ‘Normal ISA Stocks’ – which at the moment is about 47 Stocks – these are a mix of things in many ways. So, the point here is that if you decide to run an Income Portfolio and maybe a Higher Risk Portfolio, this will also impact on your ‘How Many Stocks?’ decision. Some people run Portfolios of larger Stocks from the FTSE350 and then have a separate Portfolio for much Higher Risk AIM Stocks etc. As you can see from this, my Overall Portfolio of everything it very highly Diversified – although in terms of Asset Classes I am very focused on Equities but I do hold a lot of Cash. Please see my ‘Trades / Portfolios’ Page for a full list of everything I hold.
Position Sizes are Dynamic – conventional ‘wisdom’ (ahem) is that a Small Focused Portfolio is the correct Approach. Some say you should have 15 stocks and 20 at the most – I think this is very poor advice. I read so much stuff which says that this or that Famous Great Investor only has 15 Stocks and I read things like “put all your Eggs in one Basket and watch it closely” and “if you have a High Conviction Idea, put all your Money into it”. I strongly disagree with this and I think it is dangerous for the Average, Normal, Investor. If you are Warren Buffett and have a proven ability to Buy Stocks, then maybe a focused Approach is correct – BUT TOO MANY PEOPLE BELIEVE THAT BECAUSE BUFFETT CAN DO IT – SO CAN THEY. The reality is that this is a sign of massive overconfidence in understanding Self Ability. It is particularly rife at the moment because we have been in a Bull Market for Stocks for the last 6 years or so. Everybody is a genius and can do no wrong and their focused Portfolios have done superbly. It is an illusion – the Market will kick the butts of such overconfident souls soon enough. One of the most important reasons to have a good mix of Stocks and plenty of them is because Average Investors (that is what I am and what most of the people reading this Blog are – by definition that must be the case) will make plenty of mistakes – holding more Stocks enables our Good Choices to outweigh our Duff Choices. I would say that 20 Stocks is the bare minimum for any Investor – any less and you think you are Warren Buffett or Seth Klarmann – you are not, and these people are Exceptional Individuals and part of a syndrome called ‘Survivor Bias’ – When you read about such Geniuses who run Focused Portfolios, you do not read about the millions of other people who tried to run Focused Portfolios and failed. Think of it like this – the ‘Gurus’ say you should put huge amounts of your Portfolio behind the latest Stock you have decided to Buy because it is such a great idea – but everyone in reality knows that just because they have decided to Buy a particular Stock does not mean it will go up – we have all bought Stocks only to see them drop from Day One. So backing this great idea would be rather silly and we cannot possibly know which of our Buys is this ‘great idea’ – in reality we think all of our Buys will do well – if not, why did we buy them? If you hold Small Stocks in a focused Portfolio it is even more dangerous. 15 Stocks might just about be OK if they were all FTSE350 but with AIM or FTSE Small Cap etc. Stocks it could be a really bad idea. Remember Smaller Stocks are prone to shock adverse Events and Profits Warnings and can fall by 30% or more in a flash, whereas FTSE100 Stocks often only fall 10% on a Warning. Leveraging up such a Small Portfolio is verging on suicidal. However, having a Portfolio of many more Stocks can actually incorporate some of the positive advantages of a Focused Portfolio – the point here is that Position Sizes within the Portfolio can and should be ‘dynamic’. In other words, simple techniques like ‘adding to Winners’, Topslicing, Small Pilot Positions, Stoplosses where appropriate, Stakebuilding, etc. can mean that you are in effect putting more money into your Best Ideas and underweighting the less good ideas – but the beauty with these techniques is that you are letting the Market tell you which Stocks to Topup on and which to Topslice – the ‘Experts’ method means you are making Judgements about the Success of the Stocks you have bought before the Market has made any Judgement on the validity of those Choices. This must be prone to Cognitive Errors – especially for anyone who has only been trading for a few years. The other problem with the Small Basket approach of the ‘Experts’ is that they give you little or no guidance on if and when to Topslice – in fact, they seem to advocate letting Stocks just get bigger and bigger. I am aware of some people who seem to do exactly this and I think it is extremely dangerous – the problem is two-fold – firstly you get a situation where one Stock becomes massively overweight and this means that the fortunes of the Portfolio become tied to one Stock in particular. This is crazy, just because a Stock has had a good run, it does not mean that it is immune to a one-off shock, unexpected Event (a Black Swan) – things like Legal Rulings, Accounting Problems, Operational Explosions / Accidents, Order Cancellations etc. can cause a meltdown in the Stock. This brings me on to the second issue which is that as a Stock rises its Risk increases – very few people seem to know this but it is quite obvious that Valuation Risk becomes greater as a Stock Rises – so you end up Overexposed to a very Risky Stock (as it rises, any Undervaluation is being eroded). Topslicing is vital to retain the essential ‘balance’ of the Portfolio – there is no point starting off with a nicely Diversified Portfolio if you then get to a position one year down the line where your Portfolio has got all out of shape and the benefits of Diversification have been lost. My view is that Topslicing should be fairly Mechancial – in other words, establish Rules for Topslicing well in advance that you follow at all times. Do not override these Rules – they are there for a reason and are for your Protection and increased Wealth. There is one Guru who actually talks more sense on this – probably because he was a Real Investor not a mere theoretician. That chap is Peter Lynch who wrote ‘One Up on Wall Street’ (you can find this in Wheelie’s Bookshop on WD2) and the aspect of his approach that has had a big impact on my Methods is his idea of having small ‘Pilot’ positions in Stocks he likes but lacks huge conviction in. I often use this trick and it makes a lot of sense – if you just add the Stock to a Watchlist it is not the same – actually buying a Small Position in the Stock with Real Money means that you really focus on the company and if it starts to make real progress as a Business, then you can add to the Position. This means many of the Positions I hold are Pilots upon which I build over time as I get better understanding and increased conviction. Peter Lynch was a Fund Manger with Fidelity many years ago and probably held more than 70 Stocks – but he was extremely successful – this doesn’t seem consistent with what the ‘Experts’ say.
New Investors – When you are starting out in Investing you may have little choice but to run a very focused Portfolio simply because your Capital is limited. There is little point in going below about £300 as a minimum to Invest in any individual Stock as the Dealing Fees, Stamp Duty and Spread will eat up so much of your Gains that you will struggle to make any headway. I suggest the Minimum to Invest in an Individual Stock is really £500 – this gives you a chance to do well, it also probably makes sense to start out with maybe £2000 so you can at least buy 4 Stocks and have some sort of Diversification across your limited Holdings – but your focus needs to be on getting more Capital to enable you to de-risk by holding more Stocks (a good idea is to setup a Bank Transfer for a regular amount each week which builds up for your Investing purposes). I guess an absolute Bare Minimum for Diversification must be about 12 Stocks but I would say 15 to 20 is much more like it. When you first start, the focus must be on getting more Stocks – this has 2 advantages – firstly you get Safety (well, at least Lower Risk) from Diversification and secondly if you have more Stocks you will have more opportunities to learn. If you are new to Investing and you just hold say 12 Stocks, you won’t really have much to do. It will be utterly tedious (especially as some smaller Stocks never move !!) and to be honest it is no good reading every book ever written or reading about loads of Stocks you don’t hold – you only learn by undertaking actual Real Experience with Real Money. You need to learn the ‘feel’ of the Market and the skills of Topslicing and Adding to Winners etc. – these are not things you can learn without actually getting your hands dirty – you must get stuck in. In fact, it is probably better to Overtrade in your first few years because of the vital learning experience it will give you, than to sit there doing nothing and learning nothing practical. You can learn every bit of theory under the Sun from Books and stuff, but most of it is useless – you must gain actual real trading experience. Avoid ‘Paralysis by Analysis’.
Risk works both ways – the trade-off with your Number of Holdings is between a Small Focused Portfolio with High Risk and a larger number of Stocks but with Lower Risk. However, it is not that simple. The reality is that Risk works both ways – both to the Upside and to the Downside. I take the view that Downside Risk is more of an undesirable problem for me than Upside Risk – if my Portfolio goes up I am happy, if it goes down, I am most upset. So, because of my aversion to Downside Risk (this is partly a psychological thing in my make-up but probably more because I am a Full Time Investor and the Number 1 Priority for me is to avoid erosion of my Capital – I would rather forego some Upside than suffer Downside of a sizeable degree), I hold a large Number of Stocks because this reduces the Downside Risk. But the problem here is that by doing this, I also reduce my Upside Risk. These things are a trade-off for any Investor and it is quite hard to judge when you are inexperienced and have not lived through a Major Bear Market like we had around 2003 and 2008. I suspect many of the people who run focused Portfolios currently of less than 15 to 20 Stocks will have larger Portfolios following the next Bear Market !! This is a really important point – one of the things I notice from Twitter and some other sources is that the vast majority of People have Portfolios that to my mind are constructed only to capture Upside – they are ‘Fair Weather Portfolios’ and once the Grizzly Bear Market Storms come, these Portfolios will be skinned alive, cooked naked in a Pot and served up for the Head Hunter’s Annual Grand Ball. I put a lot of effort into constructing my Portfolio to be Diverse – I will still suffer badly in a Bear Market (it’s pretty much unavoidable), but with a bit of Hedging my Risk is hugely lower than most Portfolios I see.
Investing Style – this consideration is partly related to Time, but it is also a personality and personal preference type of thing. I am very much a Lazy Investor and I really don’t want to be looking at my Stocks all day – and I if want to take a Day away from the Markets, I want 100% freedom to be able to do that – this is really important for me as there is more to life than the poxy Stock market (ok, I am only joking, of course the Stockmarket is more important than anything !!). However, if you are an aggressive and more active Investor (dare I say, a ‘Trader’) who uses tools such as Stop Losses, Limit Orders and suchlike, and you spend your time with your eyes fixed on your Screens and your Stocks and you trade both Long and Short, then you can run a much more focused and less diversified Portfolio – there is no problem with this, but you need to be very skilled to do this. If this is how you Trade and you find it tiring and your Results are poor, then this style is probably not for you and you should ease back and become a Lazy Investor – it is a damned sight easier and can still be extremely profitable. Time is a factor here because I doubt that many people with a demanding Full Time Job can really spend their time looking at their Stocks on the Screen – so a larger Portfolio is needed to reduce your Risk – 20 Stocks is a sensible minimum.
Age and Risk Attitude – the younger you are, the more Risk you can take, simply because if you screw up (you will !!) then you have time to catch up from the inevitable Drawdowns you will suffer. If you are Investing at an older age, say in your 50s, you need to be careful of the Risks you take on as a serious Drawdown on your Portfolio could have very detrimental impacts on your Retirement Plans and you may end up working for many more years than you would like to. If you screw up in Middle Age, you have less time to catch up from the errors.
Expectations of Annual Returns – regular Readers of my spiel will know I am almost dogmatic about the importance of having Realistic Return Expectations and how this can impact upon levels of Risk that Investors submit themselves to. My personal Risk Level is flippin’ low as I hate losing money (I am a Full Time Investor and I don’t ever want to get a Real Job again – so I cannot allow myself to take silly Risks which will put my Capital in Danger), and the problem arises because if you expect to make Returns in excess of 10% to 15% CAGR (Compound Annual Growth Rate) you will probably need to take on too much Risk. Part of that Risk will arise from having a Focused Portfolio with maybe less than 15 Stocks – you can easily delude yourself from a few good years in a Bull Market that a Focused Portfolio is the right thing to do and then a Bear Market hits and all of a sudden you will wish you had a Larger, more Diversified Portfolio.
So, that is a list of the Factors you need to consider when deciding on how many Stocks you want in your Portfolio and of course this number can change and evolve as you refine your Approach and chosen Methods over many years.
Here are some possibilities for how many Stocks to hold, based on my Experience and Approach:
12 Stocks – this is the intended size of my Income Portfolio (currently it has 11 and I am looking for 1 more) but in time I might push this up to 15. I am however very conscious that this is a small Portfolio – and for this reason I put a lot of thought and effort into Diversification and try to hold Stocks from different Sectors. If you have a Portfolio of Funds, then maybe 12 to 15 is a good number to hold. Many people advocate a very focused Portfolio like this for all their Holdings – I think this is quite dangerous unless you are an extremely experienced Investor with a long Track Record of success. I do not consider myself to be good enough an Investor to be able to run such a tight basket – anyone reading this who is less experienced than I am may want to think hard about this !! More Diversification reduces Risk by minimising the Errors Investors make. It’s worth realising also that even the Great Robbie Burns (The Naked Trader) probably has 30 to 40 Stocks – I can almost guarantee that nobody reading this Blog is a Superior Investor to Robbie (sorry, Mr Buffett, I didn’t see you reading over my shoulder).
20 Stocks – this seems like a nice manageable sized Portfolio for an Investor who works Full Time and has lots of Lifestyle Demands for time. It is quite focused and allows an amount of Diversification – but effort must be put into making sure you hold different Sectors, Themes (growth, value, Income etc.) and Market Capitalisations, etc. If you have say £20,000 of Capital in total, then 20 Stocks would give you a nice Spread and you could have some Fun and Learn from having plenty to do.
30 Stocks – for a Full Time Investor or an Investor who works in a Full Time Job but has a real Passion for Stockmarket Investing, this is a good number. Lots of Diversification and you could have a few Pilot Positions and maybe some Higher Risk ‘Punts’ with Stoplosses if that is your wish – but be careful obviously.
40 Stocks – This is where I want my Main ISA Portfolio to be – enables a vehicle for my Passion for Stocks and will enable Pilot Positions and some Higher Risk stuff – a great Portfolio to Leverage Up safely using ‘Mirrored’ Spreadbet Positions. Being a Full Time Lazy Investor, I have no problem in managing a Portfolio of this size (I actually have about 47 or so Stocks at the moment). In addition I hold my Income Portfolio and Overseas Unit trusts but these take very little effort and they are a Hedge against my abilities as a Portfolio Manager – if I screw up, then hopefully these other Portfolios may do OK and save me from myself !! (this is actually quite a serious point and it is worth Readers thinking about this – are you really that brilliant an Investor or would it be a good idea to Hedge your ability by Outsourcing some of the Fund Management task? We have had an amazing Bull Run – was your success down to your Superb Skills or were you just a lucky ‘Monkey with a Pin’?)
To an extent, it is really about holding as many Stocks as you feel ‘comfortable’ with – it is a very personal thing and there is no Right or Wrong answer. As I mentioned earlier in the Blog, it is probably better to have too many Stocks when you are a New Investor as this gives you more opportunity to learn and as time goes on, you can cut down the number of holdings if you feel that will improve your Results – and if that experiment fails, you can go back to more Stocks.
I hope that gets you thinking – it is a much more complicated Subject than most people appreciate.
Article written by @wheeliedealer
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