What is the ideal number of ASX shares to have in your portfolio?
This is often one of the first questions that new investors ask and, unfortunately, there is no clear-cut answer (annoying, huh).
This is because several factors need to be considered, including the amount of money you have available to invest, your risk tolerance, and your personal investment goals.
Luckily, you have The Motley Fool Australia to lean on for some no-nonsense advice. We’re going to tell you our opinion on this topic, but before we get to that, let’s talk about the key guiding principle you should use to make this decision. It’s called diversification.
Diversification is a method of managing risk whereby investors spread their investment dollars across multiple stock holdings. A diversified portfolio will hold numerous ASX companies operating in different sectors of the economy and varying industries. This spreads the portfolio's risk, and we’ll explain how this works in a minute.
So, let’s get to answering the original question.
Here at The Motley Fool Australia, we recommend to our members that most individual investors need to hold somewhere between 15 and 25 shares in their portfolio to experience the benefits of diversification.
If you’re just starting out in building your portfolio, try a handful of ASX shares and build your holdings over time. Aim to hold at least 10 stocks as you continue to add to your investments when your budget allows.
For investors with significant funds already in the market, more than 30 shares might be required to be fully diversified. There is no ‘one size fits all’ answer. The right number of shares is different for every investor, and can change over time.
The actual number of shares you should buy in each company depends on the share price and the amount of money you have to invest, your goals, and your style of investing.
The dangers of a concentrated portfolio
Although it can be tempting to go ‘gung ho’ on a promising investment opportunity, research has shown that diversified portfolios tend to provide better returns than individual investments over the long term for a given level of risk.
This is because shares and industries will perform differently as the market moves through economic cycles. Concentrating your portfolio too heavily on one company or sector will leave you overly exposed to unsystematic risk, which is the risk associated with a specific company or industry.
Examples of unsystematic risk include regulatory and management changes, the emergence of new competitors, and product recalls – all of which can impact the performance of specific companies and industries, with a flow-on effect on their share prices.
For example, if you concentrated your portfolio on travel shares, you would have suffered heavy losses with the onset of COVID-19. A more diversified portfolio would have provided some insulation against the market downturn.
The benefits of diversification
As the number of stocks in your portfolio increases, its overall volatility should decrease. Owning more shares can therefore assist in offsetting higher risk strategies.
But you shouldn’t buy shares just to expand your portfolio. Do your research and aim to buy quality companies that you believe will help you achieve your investment goals.
Can you be too diversified?
If you are investing in individual ASX companies, you need to have the time and motivation to keep up to date on their performance and industry news.
For individual investors, this becomes more difficult as the number of stocks in their portfolios increases. Owning too many investments might confuse and add layers to your due diligence. These layers can impact your decision-making as your focus can be spread too thinly, and therefore you won’t know your companies as well as you would like.
Being too diversified can also bloat your portfolio with average companies that you’re not that excited about. Who gets excited about their 50th best idea? Holding yourself to a discipline of moderate concentration ensures each company you own has earned its place in your portfolio.
Research shows that holding 20 or more stocks will ameliorate most company-specific risks. This is the type of risk that diversification is designed to protect against.
What diversification cannot protect against is market risk or systematic risk. All stocks are exposed to market risks, such as a slowdown in the economy or a change in interest rates. It is not possible to diversify against market risks.
How ETFS can help you diversify
Too much diversification is not as much of a concern for investors who aren’t focused on outperforming the broader market returns through stock picking. For these investors, exchange-traded funds (ETFs) can provide a simple but effective investment method.
Many investors use ETFs, which hold a basket of different shares, to achieve diversification.
The simplest form of ETF is an index ETF, which aims to mirror the performance of the largest companies on the market. An example is the iShares Core S&P/ASX 200 ETF (ASX: IOZ), which holds a basket of the top 200 stocks on the ASX by market capitalisation.
This ETF aims to deliver the same returns as the overall benchmark S&P/ASX 200 Index (ASX: XJO). Generally speaking, it is an easy way for investors to gain instant diversification across the top 200 companies on the ASX in a single trade.
To put it simply, the iShares Core ETF purchases the top 200 shares in proportion to the market capitalisation weighting that each company represents. The fund mirrors the index’s performance (fewer fees).
Being exposed to 200 ASX shares could arguably be too diversified for some investors if attempting to beat the broader market’s returns. However, a diversified ETF could be a fantastic solution for passive investors who are content with overall market returns with minimal involvement.
Besides, the S&P All Ordinaries Accumulation Index (ASX: XAO) has returned an average of 9.7% per year to investors over the past 30 years, according to the 2021 Vanguard Index Chart. That’s certainly not a bad return for a ‘set-and-forget’ approach.
Another way of diversifying is by using theme-based ETFs. An example is the BetaShares Global Sustainability Leaders ETF (ASX: ETHI), which holds a basket of large global companies from many industries that meet strict sustainability and ethical standards.
Some ETFs provide exposure to one industry, such as the BetaShares Australian Resources Sector ETF (ASX: QRE). This ETF tracks the performance of the most significant ASX resource shares. Instead of buying the big miners individually, this ETF offers a cost-effective way for investors to gain exposure across the wider sector.
Last updated May 2022. Motley Fool contributor Katherine O'Brien has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.
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