Following up on Part 1 of the portfolio-construction series of articles in which I talked about how much of a stock we should own, this article will now discuss the next most important aspect of portfolio construction: The “correct” number of companies we should have within our portfolio.
No fixed answer
I should perhaps first state that there is technically no “right” or “wrong” number of companies to own within one’s portfolio. Looking at a typical mutual fund, it can have anything from shares in 20 companies, to more than a hundred. Meanwhile, some hedge funds I have looked at previously owned shares in more than 300 companies!
A fund’s investment mandate and philosophy would determine the strategies used by the fund manager, and it would also ultimately determine the optimal number of companies held within the fund. We as investors can take a cue from this and also ask ourselves what our investment philosophy and strategy is, so that we can reasonably determine how many companies’ shares we should hold.
Letting philosophy and strategy decide
If our strategy is more active and requires a lot of switching in and out of positions, it may be desirable to hold more companies (20 to 30) so that we can capitalize on trends and valuations to determine when to buy and sell, thus recycling capital to grow our portfolio. But a more passive strategy may require fewer companies, as these will be “core” companies that require much less monitoring from us.
Another factor to consider would be how much time and effort we would like to spend to monitor the companies within our portfolios. Tracking the developments of a company’s underlying business and industry is time-consuming, and the more companies we hold, the more daunting a task this becomes. With 10 companies for example, an investor with a full-time salaried job may still be able to allocate time to read through quarterly reports. But with 30 companies, this would be too tedious in my view. A full-time investor, on the other hand, may have the luxury of time to be able to closely monitor 20 to 25 companies.
From the above, you should be able to get a sense of what kind of investor you are, and to determine the optimal number of positions you should hold within your portfolio. In the next part, I shall discuss sector and industry exposure and overlap. [Editor’s note: Part 3 of this series has been published. It can be found here.]
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