Seeking Good Returns? Overinvestment Is Not The Way To Go
We got the opportunity to glance through the data of several real-world mutual funds and stock portfolios (belonging to Indian investors) in the recent past. The numbers we saw were a complete revelation. A vast majority of the portfolios were way heftier than what’s necessary and some were just outright gigantic.
We were quite surprised to see most of these investors were equipped with portfolios that were so huge in size. Among the samples we scanned through, 50% of the stock portfolios were made up of about 50 stocks a piece, with 10% of them having them more than 100 stocks in a single portfolio. These figures were shocking for us, to say the least, and we’re actually doing more than justice to the word. In our opinion, 50 to 100 stocks in a single portfolio is a very large number; even if we take mutual funds into account, which have a dedicated research staff and professional fund managers. If you ask us, we recommend no more than 38 stocks, despite us having a team of analysts, who get ample support from the rest of the staff of our organization.
So this begs the question – what’s the ideal number of stocks one should invest in? The answer is completely dependent on the investor’s ability to comprehend and examine investments.
If an investor decides to invest in a number of stocks (such as 50 or more), it displays their lack of research before investing. Even a short study of these portfolios attests to the fact. When we analyzed the portfolios, we found out one thing – all of these investments had been recently made, making the portfolios short-term in nature. Plus, the selected stocks are momentum stocks. Most of the investors directed their focus on small-cap and smaller mid-cap stocks. The thing about these stocks is that they have recently started moving, with no real reason behind the gains they’ve made. The larger stocks in the portfolio too belong to this category.
Of course, some of the stocks are quality long-terms one, but if you take their weightage into account, they’re all momentum stocks. This, coupled with the number of stocks invested in, makes it clear that people do not think much before investing.
So we come back to the same question – what is the magic number of stocks one should invest in? The answer, unfortunately, does not lie in a number. As stated before, it depends whether an investor can understand and analyze the stocks in question. In case the investor cannot fathom the rationale or logic behind an investment, it’s best to avoid it. If you want numbers, they could 2 or 3 or even 10, but the thing is 50 is a highly unlikely number. The moral of the story is that it’s not about numbers, it’s about bandwidth.
Take a look at some of the greatest investors, Berkshire Hathaway’s Charlie Munger and Warren Buffet, for example. They had full access to all kinds of research in the world, but yet they did not invest in tech for eons. Why? They simply did not understand technology and hence, did invest in it. That’s not to say they couldn’t have hired someone who did get it to help them out, but they avoided tech because they couldn’t understand it all that well on a personal level. This might seem a bit extreme on the surface but as far as investors are concerned, it should be a norm for them rather than exception. Of course as an investor you should try to expand your knowledge base with the help of tools and services. However, you should know that these are just tools and services at the end of the day.
That said, if you are investing for the first time and think that it takes up too much of your time and effort, mutual funds are the best choice for you. Again, overinvesting is a problem with mutual funds investors too. But the good news is that we can give you an ideal number for mutual funds investment along with the rationale behind it.
A couple of years ago, we conducted an in-depth simulation of investments, putting in our money in a number of different funds for varying time periods. The simulation taught us that the ideal number, both in practical as well as theoretical terms, never went beyond 4 or 5. The reason behind this number is that it strikes the perfect balance between overhead management and diversification. Besides, depending on how you choose the funds you invest in, you also get the chance to earn maximum returns.
If you go beyond 4 to 5 stocks, say about 7 to 8, the returns you earn would be more or less average rather than high. If that’s the kind of returns you earn, you’d rather simply invest in one low-cost index fund or ETF and get rid of the headache of investing in multiple places.
The bottom-line is that irrespective of how you perceive it, a small number of investments that are comprehensible to you is the right thing to do.