Back when I was a portfolio manager for a boutique hedge fund, we had some quirky clients.
I remember one of our clients wouldn’t let us place a trade in his account on Friday the 13th because he was superstitious.
Another vacationed on a private island and I had to meet him at a boat landing just to get important papers signed.
One client even had a multi-million dollar trust that we had to swear never to tell his immediate family members about. Talk about an awkward situation!
But the one client that really sticks out in my memory was an heiress to the Coca-Cola Foundation — a big deal in my home state of Georgia.
As far as I could tell by doing the math, her net worth was close to one billion dollars.
But all of that money didn’t keep her from making one of the worst mistakes even a rookie investor should avoid.
Today, I want to make sure you’re not making the same mistake!
Too Much of a Great Thing
Can you have too much of a great stock?
That’s the question I often hear from investors who are committing the same mistake as my former client.
Many investors get excited about a single stock because they love the story behind the company.
You’ve probably been there yourself — I know I have!
You love the cars that Tesla makes, so you load up on shares of Tesla.
Or maybe you realized what an important tool Zoom would be in our coronavirus crisis world and participated in the four-fold increase from Zoom.
A concentrated position in one great stock can make you look like an investment genius! And if things go well, you can increase your wealth by a tremendous amount.
But as we all know, concentrated positions in just one or two big stocks can also carry a tremendous amount of risk.
If something goes wrong at the company — or even if other investors just lose interest — the stock can come spiraling down.
That’s a recipe for disaster when it comes to your retirement wealth.
This heavy concentration in a single stock is the biggest mistake that our hedge fund client was making when I started managing her money.
Her family had accumulated hundreds of thousands of shares of Coca-Cola over the years.
And while that position had done well, the wealth of their entire family was at risk if anything bad happened to the Coca-Cola brand.
That’s why she hired us to help her diversify her wealth into other investments while still generating the income she was used to receiving from her shares of Coca-Cola.
And that’s what brings me to our retirement question for today…
How many stocks should you hold in your retirement account?
The Importance of Diversification
When it comes to investing, there are some important concepts to keep in mind.
First and foremost, the more stocks you have the less risk you have of any one of the companies blowing up and hurting your retirement.
Sure, the value of your wealth will still fluctuate when shares trade higher or lower. But your stock-specific risk will decrease every time you add a new position.
On the other side of the coin, we also have to think about how many stocks we can research and know enough about.
I love investing and getting to spend my entire day looking at opportunities to grow your \wealth.
But even though this is my job, I can still get covered up with the sheer amount of research it takes to know all of our positions well.
We’ve even got a full-time research staff to keep me up to date on everything that is happening.
All of that is to say there’s a point where owning too many stocks can be counterproductive.
If you’re just adding more stocks without really researching which stocks are the best for your retirement, you may just be diluting your returns with too many marginal positions.
So How Many Stocks Do You REALLY Need?
I’ve done a lot of studying about diversification, investor returns and the optimal way to set up an investment portfolio over my career.
Joel Greenblatt, author of “You Can Be a Stock Market Genius,” has compiled a lot of statistics on this subject.
He found that if you own eight different stocks in your account, you’ll reduce about 81% of the individual stock risk.
And if you own 32 different stocks, you’ll eliminate 96% of single stock risk.
Put simply, that means that you’re protected from the risk of one company taking a toll on your wealth.
And at some point when you already have a healthy number of stocks, adding another position to your portfolio doesn’t really give you any additional benefit from diversification.
The takeaway here is to make sure you’re spreading your investments into several different stocks. I recommend at least 10 positions if at all possible.
But once you reach 30 or so positions, it’s probably best to only add another stock if it’s better than one of your existing positions. And it’s smart to go ahead and sell that worse position to make room for the new stock.
Of course, you still need to make sure that the different stocks that you own are in different areas of the market.
If you own 10 energy companies, you’re still taking on all of the risk for that particular industry. This approach is basically owning several variations of the same stock. It just doesn’t make sense.
Thankfully, there are plenty of opportunities to grow your wealth and generate great income from many different areas of the market. And of course, we’ll be covering the best ones right here at Rich Retirement Letter.