This is often one of the first questions that new investors ask. Unfortunately, there is no clear-cut answer (annoying, huh).
It's because several factors need to be considered, including the amount of money you have available to invest. You also need to factor in your risk tolerance and personal investment goals.
How many shares for a strong portfolio?
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. This unlocks the benefits of 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 risk and is a key guiding principle you should use when deciding your portfolio composition.
Start smaller and build up
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, your goals, the amount of money you have to invest, and your investment style.
The dangers of a concentrated portfolio
Although it can be tempting to jump 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 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 these 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 in 2020. A more diversified portfolio would have provided some insulation against the market downturn.
Building a better share portfolio
As the number of stocks in your portfolio increases, its overall volatility should decrease. Owning more shares can, therefore, help offset 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 the time and motivation to keep up with 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 thin, 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 can ETFs 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.
Index ETFs
The simplest form is an index ETF, which aims to mirror the performance of the largest companies on the market. The iShares Core S&P/ASX 200 ETF (ASX: IOZ), for example, holds a basket of the top ASX 200 stocks 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's an easy way for investors to gain instant diversification across the top 200 companies on the ASX in a single trade.
Put simply, the iShares Core ETF purchases the top 200 shares in proportion to each company's market capitalisation weighting. The fund mirrors the index's performance.
Theme-based ETFs
Another way to diversify is to use theme-based ETFs. An example is the BetaShares Global Sustainability Leaders ETF (ASX: ETHI). This ETF 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.
Set and forget
Exposure to 200 ASX shares could arguably be too diversified for investors 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.
According to the 2021 Vanguard Index Chart, 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. That's certainly not a bad return for a 'set and forget' approach.
