One of most important things you need to decide for your portfolio is how many different shares you're going to own. If you buy 100 different shares then you may as well have owned an index like iShares S&P 500 ETF (ASX: IVV).
There isn't a 'right' answer to this question. However, Rachel Folder, an analyst from Naos Asset Management, has written an article about how high-conviction portfolios will likely outperform the market over the long-term.
Naos runs a few successful listed investment companies (LICs) like Naos Emerging Opportunities Company Ltd (ASX: NCC) and NAOS Ex-50 Opportunities Company Ltd (ASX: NAC). Both of these LICs have outperformed the ASX index since inception before fees and had a minimal number of holdings, usually between 10 to 15.
Ms Folder mentioned one of Warren Buffett's best quotes: "A lot of great fortunes in the world have been made by owning a single wonderful business. If you understand the business, you don't need to own very many of them."
Benjamin Graham advocated 10 to 30 holdings whilst Warren Buffet suggested five to ten.
Here are some reasons Ms Folder suggested for holding a small number of shares:
Holding too many shares in a portfolio can crowd out returns for good ideas
The more shares that are added to a portfolio the less of an impact a good idea will have on the total return.
I personally like to call this concept 'di-worsification'. Adding more shares for diversification's sake alone isn't a good idea as it can dilute returns.
Good ideas are scarce
According to Ms Folder's numbers, over the last 3 years to June 2018, 4 stocks in the ASX300 Industrials Index have been able to earn an annualised return of over 100%, and 15 stocks earned over 50% annualised return.
This shows that, in hindsight, you only need to find those few high-performers to create truly wonderful returns for your portfolio. The hard part is finding those market-winners before the rest of the market does.
Competitive knowledge advantage
It's better to completely understand a small number of businesses than know a little about a lot of businesses. If you have done detailed research and know your shares very well then it gives you a better chance of knowing if your idea is a market-beater and whether it's an opportunity missed by the market.
Diversification isn't lost
No-one is advocating that your portfolio should be just one share. There is probably a sweet spot of between five to thirty holdings where you have given your portfolio enough diversification to mitigate risk without damaging your overall returns.
Foolish takeaway: The proof is in the pudding
You just have to look at the portfolios of market-beating investors like Warren Buffett, Naos, Magellan Financial Group Ltd (ASX: MFG) and others to see that owning a small selection of quality long-term growth businesses can create strong market outperformance. I myself am trying to limit my portfolio to under 30 positions.
