By Justin May, Portfolio Manager

In short: Yes, you should own every stock you can. Over time, the stock market is made up of many losers and very few big winners; the more stocks you hold, the greater your probability of holding those winners. If you face tax constraints, a portfolio of 150-200 stocks is sufficient to emulate market performance. This analysis looks at how many stocks to own for better long term performance.

In a recent blog post, I explored how the average stock underperforms the broad market. Performance of the overall market is driven by a few companies with spectacular returns, while most lag. So, an investor holding any one stock should strongly consider diversifying their portfolio sooner rather than later.

But how will an investor with 10 stocks perform compared to the market? How about 20 stocks, or 50, or 100? If, for example, one in every 10 stocks goes ‘to the moon', is a portfolio of 20 stocks enough to consistently track the market?

Research on the topic is surprisingly sparse, and not so interesting for clients of Old Peak. Most studies address “unsystematic” (company or industry-specific) risk; they conclude that a portfolio of 10-50 stocks has a risk profile similar to the market¹. But I’ve never met an investor interested purely in volatility – a portfolio that loses money over time might have the same volatility as one that triples in value. Performance is paramount over risk for investors.

A few papers do address the performance of portfolios with varying degrees of diversification, but each uses methodologies more relevant to institutional managers than end investors. Inspired by their research², I created my own experiment to explore the titular question. I first assembled a list of over 500 stocks with performance lasting at least 25 years; this list represents about 75% of the current S&P 500 by market cap. From that list of stocks, I created 5,000 ‘concentrated’ portfolios of 20 stocks, and 5,000 ‘diversified’ portfolios of 200 stocks. I calculated the performance of each of the ‘concentrated’ and ‘diversified’ portfolios, and I compared their return to the ‘market’ (in this case, the entire list of available stocks).

How Many Stocks to Own

The graph below summarizes the results. The horizontal x-axis represents return versus the “market”/pool of stocks, where the market’s return is 1. The vertical y-axis shows the number of portfolios out of 5,000 at each level of return.