Weekend Reading – How many stocks are enough?
Welcome to some new Weekend Reading material – the how many stocks are enough edition.
Before sharing some of my favourite finds and articles from the personal finance and investing blogosphere this week, here are some of my recent articles just in case you missed them:
I believe financial independence really boils down to two major things:
1. Save and increase your savings rate for investing over time, and
2. Invest your money wisely.
On that note, I posted my June 2022 dividend income update here – something I’ll work on over the weekend, tally my update for July, and update you next week! (Spoiler alert: the result will be higher than $27,212! Yay!)
In this Weekend Reading edition, I shared a link to a free FI calculator – to show you how your savings rate (when it increases over time) can a be signifcant enabler to wealth-building and therefore financial independence.
How many stocks are enough?
Kidding, but only partially.
What I mean by thousands is that for many investors, owning thousands of stocks from around the world can certainly help simplify your stock selection process AND fuel your financial independence dreams at the same time. We wrote about as much this week at Cashflows & Portfolios when we covered the Best ETFs to Own to Build Wealth.
With any all-in-one ETF (Exchange Traded Fund), you can:
- Eliminate the need for manual fund/asset rebalancing. Simply buy and hold the ETF, and buy and hold some more over time!
- These ETFs have your personal investing risk tolerance already designed in.
- Such ETFs are already globally diversified, including a small portion of Canadian content.
There are many all-in-one fund providers (Vanguard Canada, iShares Canada, and Bank of Montreal tend to lead the pack of offerings) but there are other fund providers as well.
However, many investors like myself prefer a bit more of a hands-on approach to the portfolio construction.
Almost 15 years ago now, I devised my “hybrid investing” approach and announced that approach on this site via my monthly dividend income updates to take advantage of what I saw was the best of both worlds:
- Use some individual stock selection, companies that have (and continue) to reward investors like me via dividends, increasing dividends, AND capital gains over time, and
- Follow some passive investing, owning low-cost, broad market ETFs to ride the coattails of market returns beyond any stock selection processing or worry whatsoever.
So, what’s the answer: how many stocks are enough?
You might have learned or read already that diversification is the only “free lunch” investors really have. As such, some dividend investors may feel they are in a pickle – feeling they need to add more stocks to help decrease portfolio volatility. The outcome of this adding exercise should be that portfolio volatility should decrease and the relative risk for each stock held in the portfolio will diminish – to a point.
Before we unpack this a bit more, here is what some experts have mentioned about how many stocks are enough:
Lowell Miller author of The Single Best Investment:
“In our portfolios for individuals and institutions we tend to carry thirty to forty stocks.”
“The more stocks you have, the more your group will behave like an index.”
“If you don’t want to hold the thirty to forty stocks that satisfy my personal comfort level, you can reduce the number – bearing in mind that each reduction increases the risk that a single bad apple in your bushel will have an excessive impact on results.”
Gary Kaminsky author of Smarter Than The Street:
“Holding 100 stocks is yet another myth of the great Wall Street marketing machine.”
“If you’re going to do your own work/research, you should feel comfortable that with 25 to 30 names, you have enough diversification and you have enough skin in the game.”
Gail Bebee author of No Hype – The Straight Goods on Investing Your Money:
“A popular rule of thumb asserts than an individual stock should represent no more than 5% of a portfolio. This would mean owning at least 20 stocks.”
“Some studies of past stock market performance have concluded that owning about 15 to 20 stocks provides the best return for the least risk.”
Stephen Jarislowsky, Canadian billionaire and author of The Investment Zoo:
“Out of the many thousands of stocks I can choose from worldwide, I therefore really only need to look at 50 at most.”
Beyond these experts, you are probably familiar with the name Peter Lynch. Lynch was popularized for running Fidelity’s Magellan Fund – a fund that earned a whopping annualized return of 29% during his 13 years running it, more than twice what the S&P 500 over the same period.
During his tenure as manager of the Magellan Fund, I read Lynch held as many as 1,400 stocks at some point. But that wasn’t the secret to his success. Rather, it was a blend of good timing, a sound philosophy, and sticking to favourable characteristics. Some of those points are included below:
Lynch on investing philosophy, style and stock consideration characteristics:
- Consider investments and their “competitive environment”.
- Select companies with “which you are familiar and have an understanding of the factors that will move the stock price”. Specific factors may depend on the firm’s “story,” but these factors can include:
- Year-by-year (upward) earnings.
- The company balance sheet should be strong.
- Look for a low dividend payout ratio (earnings per share divided by dividends per share) and long records (20 to 30 years) of regularly raising dividends.
- Select companies whereby “the name is boring, the product or service is in a boring area…”
- The company is a niche firm controlling a market segment (e.g., railroads).
- The company produces a product that people tend to keep buying during good times and bad.
- The company can take advantages of technological advances, but is not a direct producer of technology.
- The company is buying back shares.
There’s no use diversifying into unknown companies just for the sake of diversity. A foolish diversity is the hobgoblin of small investors. That said, it isn’t safe to own just one stock, because in spite of your best efforts, the one you choose might be the victim of unforeseen circumstances. In small portfolios, I’d be comfortable owning between three and ten stocks.
So, while index investing is great, and I’m all for it for some investors, I have a bias to my hybrid investing approach and I’ve found my sweet spot is aligned to Stephen Jarislowsky as an individual stock selector for ample diversification, index investing beyond Canada for assurance, meaning:
“I therefore really only need to look at 50 at most.”
How many stocks are enough summary
Over time, while at the time of this post I have owned over 40 individual stocks from Canada and the U.S. for income and growth, I’m now closer to my sweet spot of 25-30 individual names for ever growing dividend income – I just index invest the rest of my portfolio for growth beyond that. 🙂
For dividend investors, diversification can be a serious issue that needs to be reckoned with.
Always remember with investing:
“it is all too often true that the same things that maximize your chances of getting rich also maximize your chances of getting poor.” – Financial historian, celebrated author and neurologist William Bernstein.
Here are my tips for any investor in Canada seeking some individual stocks to buy and hold, and hold some more.
Step 1. As part of any initial, beginner portfolio construction, consider indexing or using ETFs first then diversify into individual stocks over time – aim to invest initially into four or five or six stocks – maybe one per sector at a time. You can read up about that approach from this book:
Step 2. When thinking about Canadian sectors to invest in, consider “TULF” stocks.
86-year-old Gordon Pape had some advice for investors recently in The Globe and Mail about how to protect your portfolio in these wild and wonderful market times…(subscribers only). I would argue “TULF” stocks are for any investing time and for the long-haul!!
“Dividends are reflections of a company’s success. Organizations that raise their payout on a regular basis are telling us they are doing well now and are confident about their future. Sustainable dividends also help to support a stock in a falling market.”
Pape highlighted the common sectors and stocks to consider for your DIY dividend stock portfolio:
- Banks – the usual Big-6 suspects.
- Utilities – FTS, CPX, EMA, among others.
- Telcos – the usual Big-3.
- Pipelines – the usual Big-3.
- REITs – various could apply but Pape favours CAR.UN and GRT.UN in particular.
Beyond Pape’s standard list, I would also identify a few low-yielding, growth-oriented stocks to consider for your portfolio. That will be the “L” in “TULF” stocks that should be the foundation of any good DIY stock portfolio – in Canada at least.
What is TULF?
- “T” for telecommunication companies (think Bell, Telus and Rogers).
- “U” for utilities (think Fortis, Emera, Capital Power, Algonquin Power, Brookfield Renewable Partners, and others)
- “L” for low-yielding dividend growth stocks with growth potential (think Canadian National Railway, Waste Connections, Nutrien, Metro, Alimentation Couche-Tard, Brookfield Asset Management, and others), and last but not least everyone’s sector favourite in Canada for dividends,
- “F” for financials (you know the names).
Buy these companies over time, over months, over years, over decades. Eventually, the portfolio will do all the income and returns work for you!
Beating the TSX (BTSX) is one approach you might wish to adopt, a highly successful approach at that, that typically lists telcos, utilities and financials (T, U, F) from the “TULF” list.
List of BTSX 2022 stocks courtesy of Dividend Strategy.
Step 3. Watch your diversification and stock weights over time – monitor – buy and hold and add some more!
As you know, portfolio diversification is the process of making sure you balance your investments so they are not tied to one industry, geographic area, or investment type. This means your stock proportions should depend on your objectives and the risks you can accept. Personally, I avoid having too many banks or utilities dominate my portfolio. I also know that market leaders and laggards both deserve a place in my portfolio – it’s impossible to know which one and when either will play leapfrog.
Ultimately, I think anything beyond a portfolio of 40-50 stocks will be both too time consuming and add minimal alpha (if any) to your portfolio. Any more stocks than this range, and you’re likely to dilute even your best choices to grow your personal wealth.
More Weekend Reading…
A BIG thank you to TD and the team at TD Direct Investing for allowing me to share my journey, details of my portfolio, and more, including navigating inflation recently!
Outstanding post and highlights from our passionate Canadian dividend investor community by Vibrant Dreamer you really shouldn’t miss!
From Of Dollars and Data:
“After examining our current crash and the crash of March 2020, I discovered a striking similarity in how stocks declined on their way to the bottom. Of course, our current crash may not have found the bottom yet, but based on the data I’m about to show you, I’m hopeful it has.”
Robb Engen from Boomer & Echo wrote about some mental accounting.
Dale Roberts wrote about building (or maintaining) his retirement stock portfolio on Seeking Alpha.
Dividend Growth Investor recently shared 26 Dividend Champions to consider for further investment research.
Have a great weekend!