Return to:Previous Page
Morningstar.com's Interactive Classroom

Course 109
How Many Investments Should You Have?

Introduction

Most of us collect something. For some, it's rare coins. For others, it's baseball cards. Still others collect clothes.

Some people collect investments. They may own a dozen funds in their 401(k) plan, another half dozen funds outside of it, and 10 or 15 stocks. In a recent poll of Morningstar.com users, the median number of holdings was 29. That's a lot of investments.

The problem with owning too many funds and stocks is that you can easily lose sight of the forest for the trees. You start out as an investor with an investment goal and a portfolio tailored to you and turn into a collector who has forgotten what your goals are.

This course will cover how to know when enough is enough.

How Many Stocks You "Need"

Diversification seekers always want to know what the optimal number of investments is. They want to have enough holdings to moderate the volatility of their portfolios. But they don't want too many holdings, because they think they're diluting their possible returns and overcomplicating their investing lives.

When it comes to stocks, various studies have suggested that you can build an adequately diversified equity portfolio with 15 to 30 stocks. In his 1930s classic, The Intelligent Investor, Benjamin Graham said that the magic number was somewhere between 10 and 30 names. In the late 1960s, John Evans and Stephen Archer concluded that 10 stocks were enough. And in the 1970s, Burton Malkiel said 20 stocks will do in A Random Walk Down Wall Street.

Don't let these numbers mislead you, though. For starters, most of these "how many stocks" stories assume random investing--and investing is anything but random, unless you're the type who chooses investments by throwing darts at stock tables. We all have our own investment styles. For example, an aggressive investor may end up with a portfolio that skews toward growth stocks, or someone in the health-care industry may end up with a heavy weighting in that sector. Their portfolios, while diversified across many names, may not be as diffuse as they look.

Perhaps more important, some studies, including one by Malkiel himself, show that the volatility of stocks has risen over the past few decades. As a result, the number of stocks you need to mute volatility likely is far greater than 15.

How Many Funds You "Need"

What about mutual funds--how many mutual funds do you need to have a diverse enough portfolio? The answer is—you guessed it—it depends. Some funds, such as target-date funds, can deliver a lot of diversification in one package, providing exposure to stocks and bonds as well as U.S. and foreign securities. Investors can arguably obtain adequate diversification by buying a single target-date fund and calling it a day.

Meanwhile, an investor could build a 10-fund portfolio and still not achieve adequate diversification, assuming all the funds focused on a similar part of the market. That may sound farfetched, but it was actually the case in the laste 1990s, when many investors amassed multi-fund portfolios with a strong bias toward growth stocks, especially technology names. Seven large-growth funds simply won't diversify a portfolio the same way owning one large-blend fund and one small-value fund and one small-growth fund would.

What You Really Need: Diversification

Simply put, the number of securities you own is less important than how diverse those securities are.

Use Morningstar.com's Instant X-Ray tool to analyze your current portfolio, if you have one. Use the same tool as you're assembling a portfolio, too, to see if your choices are as diverse as you think they are.

You're looking for two things: A heavy emphasis on a single security type or industry, such as growth stocks or energy names, and holes in your portfolio. More than one large-growth fund or energy stock, for example, won't add much to your portfolio.

The odds are pretty good that if you own multiple investments doing the same thing or you are considering investments that do the same thing, one is better than the others. Focus your money on the best choices.

Don't forget that you can have overlap even though you own just a small number of securities. Conversely, even if you own a lot of investments you could still have gaps in your portfolio.

The bottom line: Don't obsess over the number of securities that you own. Instead, concentrate on their diversity.

Quiz 109
There is only one correct answer to each question.

1 What's the biggest problem with being a collector of investments?
a. Collectors have to do a lot of paperwork.
b. Collectors make less money than noncollectors.
c. Collectors can easily lose sight of their goals.
2 Studies in the past have shown that you should own how many stocks?
a. One to 10
b. 10 to 30
c. More than 30
3 According to Morningstar's study, how many random funds does it generally take to be diversified?
a. Four
b. Seven
c. 12
4 Which is the most diverse portfolio?
a. One that owns 4 securities
b. One that owns 10 securities
c. It depends on what the securities are.
5 When it comes to building a diversified portfolio, which is the most important?
a. How many stocks you own
b. How many funds you own
c. How diverse your securities are
To take the quiz and win credits toward Morningstar Rewards go to
the quiz page.
Copyright 2006 Morningstar, Inc. All rights reserved.
Return to:Previous Page