My family and I like to put together a puzzle or two during the holiday season. When my daughter was young, the puzzles were simple and easy to manage. As she grew older, they became more complex and took several days to finish. Obviously, a puzzle with twenty pieces is easier to handle than one with thousands.
YCHARTS tracks more than 28,000 companies. Can you imagine assembling a 28,000-piece puzzle? When building your investment portfolio, how do you pick the best stocks from 28,000 publicly traded companies? And how many companies should you own to diversify your portfolio? 10? 25? 100? 400? A study by the American Association of Individual Investors suggests owning more than 400 stocks. Owning 400 stocks can reduce your diversifiable risk by 95%.[1] Dimensional Fund Advisors recommends holding 11,000 companies.[2]
How can you achieve diversification?
- Buy several stocks. You can, of course, buy as many stocks as you want. Jim Cramer suggests owning between five and ten companies and committing an hour of research per week for each one you own.[3] If you own 20 companies, expect to dedicate 20 hours per week to review your holdings.
- Purchase index funds. A portfolio of index funds will hold hundreds, if not thousands, of companies. An advantage to owning index funds is achieving diversification at a low cost. If you purchase four, five, or ten index funds, you can simplify your financial life because it’s much easier to follow a few funds when compared to tracking hundreds of companies.
Life is a puzzle, and there are many roads to financial success, so travel one that makes sense for you and your family.
It’s not about the pieces; it’s how they fit together. ~ Anonymous.
November 15, 2021
Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.
Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.
[1] http://www.aaii.com/journal/article/how-many-stocks-do-you-need-to-be-diversified-.touch, AAII Journal by Daniel J. Burnside, July 2004
[2] https://my.dimensional.com/insight/purely_academic/23691/, Effective Diversification and the Number of Stocks by Jim Davis, 9/26/2008.
[3] http://www.cnbc.com/id/100765791, Lee Brodie, 10/7/2014, Stocks, How Many is too Many?