As an investor, a conundrum you will have to deal with while investing in equity markets, is what is the number of stocks you have to load up on in your portfolio. There are over 4,300 stocks classified as ‘active’, trading on BSE while on National Stock Exchange, the number crosses 1,600.
So, how many stocks should you own? Diversification, when not done for the right reasons, can become a recipe for mediocre results. Further, unnecessarily high portfolio churning and its associated costs, will dent returns. As an individual investor, you should own fewer stocks than the number of fingers on your hands. The ones with a large portfolio need not own above six or seven well-selected stocks. Smaller capital investments should consider holding only three or four stocks.
No doubt, diversification can lower risk by reducing an investor's exposure to any one stock. But a big portfolio of 20 or 30 names can be unwieldy, leading to confusion, and dilution of returns. It’s best to keep things manageable.
If you grab a stock that rises 200% but you have 29 other stocks of equal proportion in your portfolio, then the wealth boost is minimal. The performance of the big winners will be drowned out by the rest of the holdings.
Also, an over-diversified portfolio takes a lot of work to watch over dozens of companies, track their performance, earnings reports, and other company developments. With a smaller number of holdings, it's easier to stay on top of the companies that you own.
A careful process of selecting companies with superior profit and sales growth, profit margins and market-leading products should narrow down the field for you pretty quickly. Eliminate the stocks lacking good chart profiles, and you end up with an even more refined (and shorter) list of potential investments.
There will be times when the right number of stocks to own is zero. When market corrects ot goes into the Bear zone, no degree of diversification can protect you adequately from losses. This is particularly true with respect to growth stocks, which can generate superior returns, but tend to fall more during weak markets.
KEEP IT SIMPLE
- Diversification cuts exposure to any one stock
- Big portfolio can lead to dilution of returns
- Certain stocks are bound to lose during market correction
The writer is CEO, MarketSmith India
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