Many investors can tell you the price of every single stock they own in the blink of an eye. But few pay attention to the actual number of stocks they own. This might look like a small detail, but as you’ll soon see, it’s strategically important.
Practice varies – some investors own just two to three stocks, and some up to 40 or 50. What makes a number “right”? Let’s start with these 3 factors of consideration.
1. Your Capital
The minimum trading unit of a stock is a “board lot”. The number of shares per lot differs across individual stocks. For example, the lot size of Cheung Kong Hutchison (001.HK) is 500 shares, which makes the lot value HK$39,250 at its current stock price. On average, the value of each lot mostly falls between HK$30,000-HK$50,000. It follows that the larger your total investment capital, the wider the variety of stocks you can own.
2. Your Time
Managing a stock portfolio takes time. Though value investors typically aren’t concerned with short-term price movements, you do need to stay alert to company news, business updates, and financial reports. If you have a full-time job and look after your investment in your spare time, managing too many stocks can be taxing.
3. Your Knowledge Level
Value investors are concerned with the fundamentals of the companies they own. That requires a reasonable understanding of the business and its revenue model, the sector it operates in, and factors that affect its future profitability. It can be challenging for ordinary investors to amass that knowledge on a large variety of companies.
So what if you score high on all the above? Should you go ahead and buy 50 stocks? What’s the advantage of owning more, rather than less?
Benefits of Diversification
Intuitively, many investors believe that simply by owning more stocks, they lower their overall risk, because it’s unlikely that different companies will perform badly at the same time. But not all diversification is created equal.
To diversify risk more effectively, consider buying stocks from different sectors whose performance is not closely related. For example, if you own an airline stock and an aircraft maintenance company stock, you might increase your risk exposure to a downturn in the air transportation business. Similarly, if you own stocks of all top five banks in China, you could be concentrating, rather than dispersing, the risk. If your portfolio is heavily into banks, consider adding into your mix of consumer goods and tech stocks, for example.
In addition, the risk of the stocks you choose does matter. The risk of your entire portfolio is the aggregate of the risk of each individual stock. If you choose 20 high-volatility stocks, even those in varied sectors, your portfolio will be more volatile than another that contains 20 low-volatility stocks.
Diversification is not about buying as many stocks as you can. What you buy matters, too.
Risk of Concentration
On the other end of the extreme, why don’t we buy just one or two of the most established, biggest, and “safest” blue-chip stocks? Indeed, that is a popular strategy for many older investors.
At the Hutchison (0001.HK) shareholders’ meeting in May last year – Li Ka Shing’s last one upon his retirement – he was welcomed with thunderous applause from hundreds of his loyal fans. Many had their life savings vested in Li’s companies, and have been handsomely rewarded. But not everyone is so fortunate.
Many investors still haven’t recovered from the shock of the HSBC (005: HK) rights issue in 2009. HSBC, another perennial favorite of Hong Kong investors, saw its stock price plunging from over $100 to $33 at one point, destroying apart of loyal HSBC investors’ savings.
Putting all your eggs in one basket, no matter how sturdy the basket looks, is a risky undertaking. Apart from the concentration of risk, and letting one stock dictate your portfolio, you are also denying yourself of the profit opportunities that other companies offer.
The Happy Medium
Amateur investors should aim to manage a reasonable portfolio of five to 20 stocks. Anything under five puts you at risk of over-concentration. Owning more than 20 requires a professional investor’s time and expertise. Whether you should go for the lower or higher end of the range should depend on your capital, time, and knowledge level.
If you are one of the many investors who has never given much thought to this, it’s time for some stock-taking! When it comes to a healthy stock portfolio, quantity and quality both matter.
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