The ideal quantity of stocks to have is between 15 to 30. It is because this number provides a sufficient enough level of diversification to lessen the risk of a single stock or sector while being limited enough for the investor to have a working knowledge of each of the stocks in their portfolio. I would like to discuss the strategies and significances behind the different quantities of stocks in this range, as well as provide examples. The first option is a portfolio of 15 stocks.
15 Stocks
This can be seen as the minimum range quantity necessary for diversification. In addition, I believe this to be a valid quantity for active investors, who may wish to closely monitor the price of each stock and make extensive analyses . This strategy requires the investor to have a high degree of confidence in their pick, with each stock having solid fundamentals. For example, I focus on investment in technology and healthcare, and would choose such industry leaders as Apple, Google, Amazon, Pfizer, Johnson & Johnson, among others, for this purpose. I believe that this selection of stocks would enable me to target both the growth potential of technology and stability of healthcare, allowing some of the best-known firms to appear in my portfolio.
20 to 25 Stocks
With this number of stocks, the investor can achieve a reasonably well-balanced degree of diversification. For example, the investments can be spread among a relatively wider range of sectors and, possibly, geographies, and the individual performance of stocks will affect the performance of the whole less. For example, I would add some stocks from other sectors, such as consumer goods, financial services, and energy, and some international stocks, such as Alibaba and Unilever, to my portfolio. This number enables the investor to focus their investment in the area they have the most confidence in while somewhat mitigating the risks associated with the other sectors.
30 Stocks
Finally, a maximum-number portfolio is 30 stocks. This number should approach what is typically considered to be enough for broad diversification. For instance, if the investor selects a number of stocks relatively close to 30, or more, only a small number of them will be uncorrelated, supportive of the idea that above 30, these stocks will not contribute meaningfully to the reduction of the risk. However, at the same number, diversification becomes unwieldy. For this to be my strategy, I would select at least a couple of large-cap, mid-cap, and small-cap stocks from all over the world. In this way, I would be assured in capturing the maximum potential of growth in various market and economic cycles. For example, I would select U.S. tech giants and pharmaceutical leaders, emerging market companies, European industrials, and Asian consumer firms.
I came across a statement made by Stanley Druckenmiller in an interview about his investing strategy.
According to Druckenmiller, “Put all your eggs in one basket and watch it very carefully….Every investor has 3 or 4 big winners and you usually know which they are. Where you get into trouble is when you do something you’re not terribly focused on. When you put 50,60, 70% or more of your assets into one asset class, trust me, you’re focused. And you are more risk averse than when you have 5-6% in something and have a blow-up”. He went ahead to say that he never uses VAR models. “I watch my P&L every day. If you are watching your P&L and your antenna is up, that’s more useful than any risk mode”. Although there is only one Stan Druckenmiller and he has never had a down calendar year, the notion of having more than 70% of your assets in a single asset class seems really scary to me. Of course, as a macro investor, he benefits from operating in markets like the currency markets where there is 24-hour trading and extremely high liquidity which means that he can get out of a position extremely fast.
A poll on Twitter inquiring about position sizing saw many participants mention that their largest position makes up between 70-80% of their portfolios. This combined with Druckenmiller’s comments, got me thinking that I have not been doing any of this right. I researched the subject once before when I created the module in my Analyst Academy course about optimal position sizes. However, because this material is part of the course my students pay for, I will save detailing the mechanics for that piece and share some of the other aspects in this article, as well as, why Druckenmiller and others are able to stomach such concentration when, for me, it is beyond extreme.
The discussion will be centered around equity portfolios, which means that there will be limited to no liquidity. Additionally, the markets and individual positions can be tremendously volatile. Firstly, I am not able to imagine having 70% of my professional portfolio in a single stock. However, what should the concentration limits be and how many stocks should you own overall? This will naturally depend on a great number of variables across individual investors but let’s consider a few.
HOW MANY STOCKS?
Obviously, the concentration limits drive how many stocks you have in your portfolio. If you have a single 70% position, it would be very odd to have 100 positions overall. Therefore, I think, let’s first think about this conceptually in terms of equal weighted positions – surely, every investor will want to size up their highest conviction bets, however, the ability to do so will depend on two main factors (i) the number of positions overall; and (ii) the risk tolerance.
In the course, I explain in detail my views of the “right” number of stocks and position concentration and describe that it is based on the individual, the type of portfolio, and the risk pull of any end-investors. At Ensemble Capital they believe that 25 stocks is the level at which an additional stock provides little additional diversification benefit. I’ve been professionally engaged with more concentrated professional portfolios and, on the other hand, I’ve witnessed wider ones.
Private partners with not enough time may not be willing to have that many, but 25-35 stocks is a popular level for many successful managers – e.g. Terry Smith – with what is commonly agreed is a relatively high concentration portfolio. This fact that the natural “right” position concentration is towards a 30-odd stock portfolio rather than a wider one is repeated by many specialists. It is useful to see that Jeremy Hosking, the founder of the eponymous Hosking & Partners, who has a good and long streak, takes quite the opposite view. Each manager will have a separate portfolio of c.150 stocks.
The blended portfolio will include 400 stocks and more. This has been an extraordinarily successful strategy. Hosking is an exception. This is what Ensemble Capital writes: “Owning 150 stocks or 350 stocks dramatically dilutes any talent you might have to beat the market without adding much in the way of diversification because you’ve already captured most of the benefits with your first 25 stocks.
Yet this is exactly what most active managers actually do”.
What they are saying is that the very best ideas you have should perform the best and also you can only have so many good ideas. Optionality in Special Situations Investing. I note that in my experience of special situations investing the Pareto principle did, in fact, apply – a relatively small number of positions delivered 70-80% of the alpha in a year. But given that one cannot know at the start of the year which six stocks will be the most successful, by having a broader portfolio you give yourself a better chance that you are exposed to the six themes which do turn out to be successful.
I believe that with a concentrated global portfolio of 30 stocks your alpha should be delivered by a spread of positions. The chart below shows our estimates of the contributors of the top 5 stocks held to the performance of Fundsmith over the ten years since inception on November 1, 2010. I have excluded the first two months not expecting the results of a two-month period to be all that informative.
The number of positions has been c.20-30 with the lowest I have been able to see c.22 but we don’t have data for every year. This is probably a reasonable average with the top 5 probably close to the pareto 20%, but the rule doesn’t quite work as you can see from the chart as whilst the top 5 have contributed c.45% the socks c.20 thence year have contributed across the spread the bottom 55%. One year the top 5 contributed almost the entire portfolio performance after take over and another the biggest contributors were the defensives because the slightly up portfolio with the remaining – many – socks in the portfolio the top 5 in negative portfolio performance. Overall, we have worked on an annual contribution to c.72%. Note that this is only a rough estimate as the individual performance data have not be declared each year.
Obviously, the fewer stocks, the more concentrated the performance will be. And if you believe in your stock-picking ability, isn’t a tighter portfolio better? And should not this sizing up your favourite bets?. I detail this in to purchase don’t think so, but then this is acquisition on which there far be able debate. .
OPINION 1
Diversification and the Reduction of Dispersion: An Empirical Analysis was one of the first serious papers on the subject, published in 1968. It reached the not-very-interesting conclusion that only 10 random stocks were required to replicate the market as a whole. It’s such an old study, and the world has changed so much, that it would be a good assumption.
OPINION 2
Meir Statman wrote How Many Stocks Make a Diversified Portfolio? Answer: About 30 or more. The paper concluded that a well-diversified portfolio of randomly chosen stocks needed to contain no fewer than 30 stocks. This was contrary to the earlier paper and to what the author said was a widely-accepted belief that the benefits of diversification were essentially exhausted when a portfolio had about 10 stocks.
OPINION 3
This Working Paper was written by Peter Blair Henry, Stanford University; Paul H. Krouse, University of California: Berkeley; Ananth Madhavan, University of Southern California; Burton G. Malkiel, Princeton University. Volatility of common stocks rose from 1962 to 1997, say the four authors. They concluded that from 1962 to 1997 there had been a significant increase in firm-specific volatility relative to market volatility, and also that the number of stocks required to achieve a given level of diversification had risen.
OPINION 4
According to the fun book, Reilly, and Brown’s. The study concluded that 90% of the maximum benefit of diversification was achieved with only 12 to 18 stocks. Of course, 10 percent is a meaningful risk – For example, most people would not take a 1/10 chance with their retirement portfolio.
Position sizing and risk
There are innumerable great quotes on position sizing by innumerable greats and we use a few in the course. Of course, these range from Druckenmiller’s concentration of bets to Hosking’s highly diversified portfolio. Many professional investors seem to equate risk with position sizing. Steve Cohen says there are three main risks. Here is an extract from his recent appearance on the Stray Reflections podcast:
“ Listen, you’re going to lose money. You’re going to take risks you’re going to lose money. I think the three things are liquidity, leverage, and concentration. Those are the three rules. If you’re in illiquid stuff, that’s a problem. If you’re using too much leverage, that’s a problem. And if you’re too concentrated, that’s a problem.”
For Cohen, the three main risks are lack of liquidity, leverage, and concentration, too much of any and an investor will be in trouble.
I loved Shane Parrish’s podcast with Joel Greenblatt. Here is what Greenblatt had to say about position sizing.
“If you have this great investment, unless it’s, you know, Tesla last year, that’s going to go 10 x and you put 2% in, uh, and it goes up 50 or 100%. You could have blown it. That could have been your worst investment of all time because you should have had a 10 or 20% position, you know, and really move the needle position.
Sizing is the most important thing – being too timid on the few good ideas that come your way is like the biggest mistake people make.
On the other hand, to take a big size, you have to be willing to be wrong, take big losses and wait for that big position to happen. The biggest positions is not the position I think will go up five or 10 times, but rather the smallest position. In other words, I will size the position larger if I do not think I can lose much money, but think it is only going to go up 10 or 20 times. If you have a stock of $10, with $9 sitting in cash with no debt, and have a small business attached to it, you can actually buy a lot of it if you do not think the $9 in cash will not dissipate. As long as there is a chance for a really big upside, you are looking at asymmetry. One of the best things I ever wrote in the best book I ever wrote, was ‚If you do not lose money, most people will look at how much they can buy by size, and then it is 99% wrong. It is how much can I lose? When I lose it. It sounds very easy, but it does not matter. By lose, I mean crazy things happen. Whether it is COVID or 2008 Lehman goes down or something like that. We are over a short period of time when people will go bankrupt. Stocks or other securities can be traded at any price in the world. That is not what I am talking about. How much am I risking?
What I’m talking about is if a reasonable person won’t lose much money, if they can pick their spot to sell it over the next couple of years, that’s what I’m viewing is how much I have at risk if I can be patient. So what I want to sell it over the next couple of years, what’s the worst I really think I’m going to do, That’s how much I’m at risk for and then how much does the reward pay off relative to that?
So if something I could lose a dollar or two in, I could easily have a 20 position because I’m not risking that 20 I’m risking. ………. Better to look at, you know, how much do I think I could lose in this investment rather than that big hairy number?**
I think this encapsulates this risk aspect of position sizing incredibly well. You can have a highly concentrated portfolio of stocks, or a much greater concentration in a few stocks, if they genuinely have limited downside and you have enough time to wait. But this can be an incredibly long time in markets.
