How Many Stocks Should You Own? Remember Warren Buffett's Advice

Dec. 22, 2015 10:30 AM ETAAPL, AXP, IBM, KHC, KO, MSFT, WFC154 Comments

Summary

  • Diversification is trumpeted as a key point of proper portfolio design.
  • Warren Buffett disagrees with diversification, with a single caveat.
  • The return spread among stocks suggests that every new holding you add is more likely to be a loser than a winner.

If you asked Seeking Alpha readers why investors should own more than one stock, the overwhelming response would easily be diversification. The idea is simple: the more holdings you have, the less exposure you have to unsystematic risk (risk associated with a particular company or industry). Now, if you asked a follow-up question, "How many stock holdings you should have?", you would end up with a hotly debated topic.

On page 129 of my copy of The Intelligent Investor, legendary money manager Benjamin Graham advocates holding 10 to 30 positions. Modern portfolio theory supported this advice, and many continue to follow its preachings religiously. According to this theory, if you own 20 well-diversified companies, each held in equal amounts, you've eliminated 70% of risk (as measured by standard deviation) and reduced volatility. Can't argue with the math (or can you?), and diversification has been harped on by many as the foundation of any properly constructed portfolio. It is likely that anyone that has had a financial advisor or even discussed finances with a family friend has heard this advice before. Always spread your capital across multiple sectors and markets is in that person's best interest. Makes sense right? Who doesn't want less volatility and risk?

Warren Buffett apparently.

"Diversification is protection against ignorance. It makes very little sense for those who know what they're doing."

- The Oracle of Omaha Himself

So, Do You Know What You're Doing?

Of course, modern portfolio theory and its offshoots were theorized between the '50s and '70s. Volatility is up since then, and stocks have become increasingly uncorrelated with the underlying market. To more clearly illustrate this point, stocks increasingly don't follow a normal distribution pattern:

*Source: Investopedia

The results of the above image have been repeated over and over in recent market studies. The

This article was written by

Michael Boyd profile picture
18.8K Followers
Compelling income and growth plays in the energy sector.

Author of Energy Investing Authority

Top 1% Analyst According to TipRanks

I have a decade of experience in both the investment advisory and investment banking spaces, with stints in portfolio management, residential mortgage-backed securities, derivatives, and internal audit at various firms. Today, I am a full-time investor and "independent analyst for hire" here on Seeking Alpha.


Disclosure: I am/we are long AAPL, AXP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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