One rule of thumb is to own between 20 to 30 stocks, but this number can change depending on how diverse you want your portfolio to be, and how much time you have to manage your investments. It may be easier to manage fewer stocks, but having more stocks can diversify and potentially protect your portfolio from risk.
Diversification is one of the most important concepts in building a portfolio. Diversification means, simply, having a variety or diversity of holdings within a portfolio or between portfolios.
Portfolio diversification can come in two forms:
• Basic or naive diversification, i.e. investing in a diverse array of asset classes (stocks, bonds, real estate, etc), also known as asset allocation.
• Diversification within asset classes: e.g. owning, for example, shares of various companies and different types of companies (large, medium, and small companies, international and domestic, shares of companies in different industries, etc.) within a portfolio of stocks or bonds.
How Many Different Stocks Should You Own?
Diversification is jokingly known as the “only free lunch” in finance — a reference to the possibility of mitigating risk by spreading out portfolio holdings across different assets, or different types of a single asset. Lowering your risk exposure can potentially increase returns.
While asset allocation and diversification are related, asset allocation is generally thought of in terms of the broader asset classes (stocks, bonds, cash), and how the proportion of each might impact your exposure to risk/reward over time. Generally, you might want a more aggressive or stock-focused allocation when you’re young, and a more conservative or fixed-income allocation when you’re older.
Diversification offers a more sophisticated way to manage the potential for risk and reward by diversifying across and within assets classes. That way if a given company or asset class performs poorly for an idiosyncratic reason (e.g. there’s a change in leadership or a supply chain breakdown), the risk of underperformance is reduced, because even if one holding in your portfolio suffers a negative impact, the others likely will not.
In this way, diversification also aims to smooth out volatility. If you own stocks for companies in different industries, when one sector gets hit — say, commodity prices crash in mining — stocks in a different sector where commodities are a major cost, like manufacturing, may go up.
This can also be true across different types of investments, e.g. stocks vs. bonds, which don’t always move in the same direction.
Thus the logic of owning an array of stocks, in different sectors, may be beneficial. This leads to the question: how many different stocks should you own?
How Many Stocks Should You Have in a Diversified Portfolio?
One rule of thumb is to have between 20 and 30 stocks in your portfolio to achieve diversification, but there are no hard and fast rules.
In stock funds — large collections of stocks managed by professionals and invested in by individuals and institutions (e.g. mutual funds, ETFs, target date funds) — the average number of stocks can vary widely, from a few dozen to a few thousand different companies.
In considering diversification across assets, it also makes sense to consider individual risk thresholds. One example is a typical investment approach used for retirement: A portfolio might be more heavily tilted towards stock when the individual is younger and can wait for those investments to grow, transitioning toward fixed-income instruments over time, as the individual’s risk tolerance goes down and they get closer to drawing on that money for retirement.
How Many Stocks Can You Buy?
The number of stocks you can buy will depend mainly on:
• Trading rules set by the company
• Your budget
• The amount of time you have to manage your investments.
There is no universal limit on how many stocks an investor can purchase. However, companies may have rules in place that prevent traders from buying up a large number of shares.
With those rules in mind, you can buy as many shares or fractional shares as your budget allows. Keep in mind that there may be fees associated with your stock purchases.
How Many Shares Are in a Company?
It varies. Companies of all sizes and revenue amounts can have a wide range of outstanding shares. Some large-cap companies might have billions of shares; smaller companies far less.
Generally, the fewer shares a company has, the more expensive their stock is likely to be. That’s because market capitalization is calculated by multiplying outstanding shares by the stock price.
For instance, let’s say Company A is currently trading at around $250 a share. Company B, which has a little more than double the number of outstanding shares as Company A, could be trading at around $125 per share.
Rules for Day Traders
Another consideration around how many stocks you can buy are day trading rules.
According to FINRA rules, a pattern day trader is:
Any customer who executes four or more “day trades” within five business days, provided that the number of day trades represents more than six percent of the customer’s total trades in the margin account for that same five business day period.
A day trade would include buying or selling or selling and buying the same stock in a day.
Pattern day traders can only trade in margin accounts and must have a minimum of $25,000 in their accounts. If you are not a designated pattern day trader, you cannot buy and sell and/or sell and buy the same stock four or more times in a five-day period.
For more information about day trading rules and maximums, contact your brokerage directly.
Getting the Right Balance in Your Stock Holdings
Another approach to diversification is to invest in broad market indexes, which track entire industries or even the entire market. Index funds, which are mutual funds that track indexes, and exchange-traded funds (ETF), some of which also track indexes and which can be bought and sold like stocks, have made it simpler for investors to achieve diversification by using a single investment vehicle.
Balancing a Portfolio with Index Funds
Though John “Jack” Bogle, founder of the Vanguard Group, launched the renowned Vanguard 500 Index Fund in late 1975, it wasn’t the first of its kind. The vision to put investors in the driver’s seat by offering them a low-cost way to invest in the entire market was shared by other institutions, and it caught on quickly with investors.
And no wonder: A mutual fund that tracks the entire S&P 500 Index, a collection of about 500 large-cap U.S. stocks, offers investors a low-cost way to access the performance of the biggest companies in America. These companies are distributed across numerous industries, like information technology, finance, healthcare, and energy. Today, these large-cap funds are still used as a general barometer for the health of the market.
Today, index funds seek to track a wide array of indexes — there are thousands of different market indexes in the U.S. alone — using investor capital to invest in every stock or bond or other security in that particular index. They typically have to buy the stock in accordance with its “weight” in the index, typically its market capitalization, or the overall value of a publicly traded company’s shares. This means that the fund will be more heavily invested in the shares of the more valuable companies in that index.
Index funds make it easy for the average investor to buy into the market and achieve instant diversification. They’re affordable, too, with lower fees thanks to taking expensive fund managers out of the equation.
Diversifying with ETFs
Although there was a precursor to the modern exchange-traded fund established in Canada in 1990, generally speaking, State Street Global Advisors is credited with launching the first full-fledged ETF in the U.S. in 1993.
Since then, ETFs have become one of the most popular vehicles for investors — in part because they offer many of the same benefits as index mutual funds, like low fees and greater diversification.
While an ETF can be traded like a stock throughout the day, they don’t need to be made up of stocks. ETFs can be made up of bonds, commodities, currencies, and more. ETFs allow an investor to track the overall performance of the group of assets that the ETF is made up of — and, like a stock, the ETF’s price changes constantly based on the volume and demand of buying and selling throughout the day.
ETF “sponsors,” the investment companies that create and manage the funds, rely on complex trading mechanisms with other sophisticated participants in the market to keep an ETF’s value very close to the value of the underlying components (the stocks, bonds, commodities, or currencies) that it’s supposed to represent.
In terms of diversification, it’s important to note that ETFs are generally passive vehicles, meaning that most ETFs are not actively managed, but rather track broad market indices like the S&P 500, Russell 2000, MSCI World Index, and so on.
That said, some ETFs are actively managed, and may focus on a niche part of the market or specific sector in order to maximize returns.
When aiming to diversify your ETF holdings, bear in mind that the ETF wrapper, or fund structure, does not offer diversification in and of itself. Investors must look to the underlying constituents of the fund — the term of art for the various securities the ETF is invested in — to ensure proper diversification.
For example, an ETF that tracks the Russell 2000 Index of small-cap stocks, is typically invested in the 2035 constituents of that index. In theory, that ETF would offer you a great deal of diversification — but only within the universe of smaller U.S. companies. If you also invested in a mid-cap and large-cap ETF, you would then achieve greater diversification in terms of your equity exposure overall.
How Many ETFs Should I Own?
As with stocks, deciding the right number of ETFs for your portfolio depends on your goals and risk tolerance. Perhaps the first question to ask is whether you’re going to use ETFs as a complement to other assets in your portfolio, or whether you’re constructing an entire portfolio only of ETFs.
ETFs as a Complement
As noted above, a single ETF could own a few dozen companies or a couple of thousand. If your portfolio is tilted toward equities, and you wanted to balance that with more bonds, a bond ETF could supply a variety of fixed-income options. This would add diversification in terms of asset classes.
But let’s say your portfolio included a large-cap mutual fund (or several large cap stocks) and bonds. But within those two asset classes you were not well diversified. You could consider adding a small- or mid-cap equity ETF and a bond ETF to broaden your exposure. In this example, perhaps you’d need two to four ETFs.
An All-ETF Portfolio
Constructing a portfolio based on ETFs is another option. In this case you could use as few as 5 or 6, or as many as 10 or 20 ETFs, depending on your aims. Some questions to ask yourself:
• Is cost a factor? Would you consider actively managed ETFs, which tend to be more expensive, or only passive ones?
• Is time (e.g. the time spent managing your portfolio) a priority?
• How much diversification do you want? It’s possible to create a very basic portfolio using just two: a broad-market equity ETF (or even a global market ETF) and a total bond market ETF.
• Might you be interested in including some niche ETFs in sectors you’ve researched that seem promising (e.g. biotech, clean water, robotics)? Although there are mutual funds that provide access to these markets as well, ETFs can often do so at a lower cost. Be sure to check with your broker or other professional.
Choosing Stocks vs. Investing in Funds
When it comes to buying individual stocks, there’s a lot to consider. And while there is typically plenty of available information about a given company — including its past financial results — that can inform a thoughtful decision, its value going forward will be determined by things that are unknown. Is the industry overall going to grow or shrink? Could the performance of that company be affected by political events overseas or at home? Are there potential disruptors and competitors who could challenge its current share of the market?
In addition, the performance of a company is not the same as the performance of that company’s stock. A company might have consistent profits in a growing industry and a politically placid environment. But the price of that stock might be high. When it comes to buying, it’s important to consider the potential of future price increases. If a stock has already done well in the past, the future growth and appreciation could be minimal.
In building a diverse stock portfolio on your own, you’ll likely go through this research and consideration process with many — possibly dozens — of stocks.
Index funds and ETFs, by contrast, offer instant diversification thanks to their structure as pooled investment vehicles. What’s more, chances are if there’s something an investor is passionate about, there’s an ETF for that. There are funds for clean energy, ones that focus on machine learning and artificial intelligence, as well as organic food and farming, just to name a few.
When it comes to investing in index funds, the process is a bit different. Once an investor figures out what kind of market they’d like to track — like all the stocks in the S&P 500 — they can look at two important factors. The first is “tracking error”: How well does the fund track the index? The second is cost. All things being equal, a less expensive fund, a fund with lower fees and lower costs devoted to marketing, trading, and compensation can mean more profits for the buyer.
No matter how an investor builds a diverse stock portfolio, it’s important to remember that all investments come with risks that include the potential for loss.
Rather than focusing on how many stocks you should or shouldn’t own, it’s probably more useful for investors to think about diversification when it comes to their portfolio holdings. Diversification — investing in more than one stock or other investment — is an important consideration when building a portfolio. But building a diverse stock portfolio can be achieved in a variety ways, whether an investor lets their passions for an industry or certain companies guide them, or they are attracted to the ease and low barrier to entry of an ETF. The key is to find the approach that works for you.
Once an investor has done the research, decided what kind of diversification makes sense, and how many stocks they should own, an easy next step is to open an account with SoFi Invest® and start trading. SoFi doesn’t charge management fees, and SoFi Members have access to complimentary financial guidance from professionals.
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