How many stock should you own?
- Aug 11, 2018
- 2 min read
How many stocks should you own?
This has been one question that has invariable haunted each and every investor, starting out with his portfolio. Today, we help you shed some light into this by sharing the results of some research work done at this end. I hope by the end of this article you’ll be confident about where the intelligent stop light starts shinning for your investment spree!
The question starts when you see so many different TV channels, so many experts and presently, so many YouTube content creators churn out 2-3 stock recommendations each and every day. At that rate, you should have 60-90 stocks to look forward to every month! But is this high number of different stocks worth your time and investment?
Let us find out what some finance researchers have to say about this! Do note that as usual, we’ll figure out our rational for investing based on the risks we expose ourselves to.
There has been considerable research done in this field, following the propagation of Capital Asset Pricing Model. The basic belief under which this research was done is that the market will only compensate you for bearing the systematic risks, i.e. Beta. Any risks that you bear which can be diversified away by diversifying your exposure will bear no compensation.
In simple words let's say you have two stock, A & Z. Both have X units of systematic risk, while only Z has Y units of unsystematic risks. So by natural course of expectation, you might believe that the Z stock should give you more returns as you bear more risk for that. But according to CAPM, you'll receive the same returns on both the stock, i.e. Risk free rate + X*(Market return - Risk free rate)
By extrapolating this theory along with Markowitz's theory of portfolio optimization, many research works have concluded that for a portfolio consisting of only domestic stocks, holding more than 53 stocks leads to no significant levels of risk diversification and reduction.
For a portfolio consisting of a mix of domestic and international investments, holding more than 63 different stocks leads to no significant risk reduction.
The thing to note about these research works is that the portfolio needs to expose itself to the broad base of sectors/ industries. This was achieved by creating a market tracing portfolio.
From an India context, this means that if you make a well diversified portfolio to bring risk and return to optimal levels, and funds are no constraints, you'll want to expose yourself to all the 12 sectors that Nifty is exposed to. You can surely expose yourself to more sectors to reduce the sector concentration risk, even further, but even that will have its limits.
So, those are the magic figures, 53 & 63, that I have found during my time spent of digging through research about risk-return optimization.
Happy investing!
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