Trying To Find The Optimal Number Of Stocks To Own

 A couple of different articles that I think can weave together for a blog post. 

The first one was in Barron's, it was a quick read studying diversification. The title tells you the author's conclusion, Why Your Portfolio Should Hold Way More Than 30 Stocks. There are countless opinions about how to diversify; a lot of stocks or not. This article obviously favors more stocks but an interesting thing not said was at what number would it make sense to just flip from individual holdings to mutual funds and ETFs. Own however many you want of course but the nuisance factor probably starts not much past 30 on the way up. 

In my opinion the diversification benefit hits diminishing returns pretty close to 40 individual holdings based on math if nothing else. If a portfolio starts with 40 holdings each with an equal 2.5% weighting (yes I am making some generalizations) how many are you likely to pick that go to zero? Not too many I'd say. You may pick many that end up underwhelming per another study I read this week (sorry no link) but that is a different issue. So while it would be rare to have one go to zero without you paying attention and taking action, I think the typical portfolio could ride out something in the 2.5-3.5% weighting range go to zero without causing serious damage.

Circling back to without you paying attention above, I owned Hawaiian Electric (HE) ages ago. I sold it so long ago I don't remember why I sold it. Would it have made sense to sell this week after that 40% decline based on the news related to the fires in Lahaina? Realistically, I think a lot of people would bail before zero so instead of risking 2.5% of your portfolio, really it's 1.25% after cutting in half which again is something that a portfolio should be able to ride out. Anyone using individual stocks needs to be prepared for being very wrong occasionally, like Hawaiian Electric wrong. 

A more interesting point was made about sector diversification. The author feels that sector dispersion, the extent to which there a big winners and serious laggards, goes a long way to determining investor performance. He cited semiconductors, specifically the huge dispersion between Nvidia (NVDA) up 233% YTD and Intel (INTC) up 15% YTD. I have a yeah but to that. 

Getting a couple of hundred percent in 7 or 8 months is going to boil down to being lucky for most people. I don't think I've ever had a client stock go up that much in less than a year but if I did, it was luck. Nothing wrong with admitting luck, unless you're Stanley Druckenmiller or someone like that, be honest with yourself on this front. 

The yeah but is a different point about diversification. If you build a reasonably diversified portfolio of individual stocks and you do some decent work on stock selection, I think odds are you'll hit a couple of monster winners if you can hold over the long term. I've got quite a few names that have been in the portfolio since 2004-2006 when I first started this phase of my career. Some have been monster winners, some have performed inline and one or two have been pretty meh but churn out big dividends so I keep those one or two. 

The chart shows two long term outperformers, names blanked out, each having much different 2023's. The chart starts when I bought the blue line stock. The yellow line stock goes back to 2004. I'd say both are monster, long term outperformers but notice both have had entire years here and there where they did badly. Tell me if I am wrong but someone who spends time researching names to include in a portfolio will end up with a couple of these, more if they are lucky. Be honest with yourself and own being lucky. I've been lucky. 

Hawaiian Electric faces going concern threats because a lot of people died. Something like that is probably a thesis breaker for whatever the thesis for HE might be. A lottery ticket biotech where the one drug kills people is probably a thesis breaker. A year of bad revenues and earnings is not a thesis breaker. A stock that is under performing just because is not a thesis breaker. Learning the difference can help know when to hold on and when to sell. Of course you won't always be right but panicking out of an unbroken stock because it lagged one year is not a behavior of successful investors. 

The other article was a blog post from whom it appears is an anonymous writer who is a portfolio manager or advisor of some sort who goes by the handle Six Bravo. It's a wide ranging post that I found via Abnormal Returns. The part relevant to my post today was about buying stocks using an inter-generational timeline, meaning buying stocks with not only the current investors' objectives in mind but also their kids and grand kids. 

That not how I approach stock or fund selection. Yes, I hope to hold anything I buy very long term and there are a couple of instances where I am working with 2nd generation clients but inter-generational time horizons is pretty much a different part of the business than what I do but that doesn't mean there aren't points to take in and possibly learn from. A long time adage we talk about all the time is to take bits of process from various sources to create your own process. 

Do you use individual stocks? If so, what's the longest you've held some names? I'm not that far from 20 years with quite a few and a bunch more are 14 or 15 years. Those time frames are kind of inter-generational but that's just how it turned out. I didn't buy stocks in 2004 thinking about 2024 or 2034 but I take from his post that Six Bravo does think is those terms.

If a company's thesis remains in tact and they continue to execute reasonably well then I am unlikely to want to sell that name out. Reduce some here and there if it grows too large in the portfolio yes, blow it out, probably not. 

This post only looked at one facet of using individual stocks, there are others and it takes some work. For most people the barriers are time available and the inclination to spend that time. It's not mystical, just time consuming.