For most household investors, your portfolio is generally a mix of three main asset classes: stocks, bonds and banking products. By banking products, we mean anything ranging from a savings account to a certificate of deposit that you hold with your depository institution. The balance that investors strike with these products is between growth, stability and liquidity. Simply put: Stocks offer growth but at the expense of volatility, especially over the short term. Bonds offer less growth, but more security and less volatility. And banks offer high security with potentially high liquidity depending on your product, but almost no growth.
With this balance, the first question for most investors is: How many stocks should they own? Let’s break down how heavily invested you should be in stocks when compared with bonds and other security-oriented assets.
If you’re unsure how many stocks to invest in, a financial advisor can help you balance your portfolio.
Heavy Market Investments, Fewer Individual Equities
When it comes to investing in stocks, you can generally take two approaches:
Funds are portfolios that you invest in, like mutual funds and ETFs. A fund will hold a large number of assets in its portfolio, from a few dozen to potentially hundreds. When you buy shares in the fund, you receive a share in the total performance of that underlying portfolio.
This means that by investing in a stock-oriented fund, you get a share of ownership in all of the stocks that the fund holds. This gives your portfolio the protection of a well-diversified series of investments. Assuming that it has been well built, no one or two companies can tank the fund’s performance as a whole. But that diversification will also dilute any single company’s gains. You don’t risk outsize losses, but you can’t collect outsized returns either.
Buying individual equities means that you have invested in a single company’s stock. For example, instead of buying a technology-oriented mutual fund, which might invest in 50 different companies on the NASDAQ exchange, you would simply buy shares of stock in Apple (AAPL). This has the opposite risk profile of a fund. If the company’s stock price falls, you are exposed to all of those losses. If the stock price does very well like, for example, Apple’s has, you will collect all of that growth.
Financial experts heavily debate just how many individual stocks you should hold in a portfolio in order to strike the best balance between risk and reward. Depending on which research you pull, you can find arguments suggesting that anywhere between 10 and 60 individual stocks will make up a well-diversified series of investments. However, for investors looking for a rule of thumb, we would suggest considering this from a budget-first perspective:
Invest with funds. Achieve diversification by investing in well-balanced mutual funds and ETFs. Find ones that have a good track record of performance and, if you don’t have a good sense of what funds would work for your portfolio, a well-indexed S&P 500 fund is one of the best investments you can make under any condition. Invest in these funds with your long-term money. This is the portion of your portfolio that you can’t afford to lose, and for most investors should represent the majority of their assets.
Speculate with stocks. Your speculation money, the money that you can afford to lose if things go badly, should go into individual equities. Research these companies well and invest based on the fundamentals, not for a quick-hit gain, but don’t be afraid to take some risks. That’s how you can get surprising growth after all.
This approach should leave you with a portfolio that emphasizes well-diversified funds, leavened with a few individual equities.
Importantly, the specific number of equities in your portfolio matters less than the value of your investment. Whether you have bought heavily into one company or spread your money around to 10 or 20 of them, the important factor is that you buy individual equities with speculation capital. You will have already diversified your portfolio with your investment capital, so the exact number of individual equities you buy will be less important.
How to Balance Your Portfolio Over Time
The other important question is how you balance stocks as an asset class against safer assets like bonds. Essentially, what should your asset mix be? Financial professionals suggest that investors should build their portfolios on a time-based method. The longer you have to invest, the more aggressive your portfolio should be and the more it should be weighted toward stocks. The less time you have to invest, the more conservative your portfolio should be and the more it should be weighted toward bonds and other safe assets.
Most financial advice places this in the context of retirement savings. For example, say you begin to invest at age 25. It would not be unreasonable for you to have a portfolio with 90% or even 100% stocks. You have the time to take advantage of the stock market’s long-term growth, and the time to let your portfolio recover from any market losses.
As you age, many advisors recommend shifting that balance. So by age 40 you might hold a mix of 70% stocks and 30% bonds. This would let you continue to gain value, while exposing your portfolio to less market volatility because you have less time to regain those losses. By the time you are 65 and nearing retirement, your portfolio may want to have flipped entirely, now reflecting 90% or 100% safe assets and few, if any, stocks.
This is, in general, the prevailing wisdom. However, it’s worth noting that some financial advisors depart from this approach. They recommend, instead, a heavier investment in market-oriented funds for a longer time. Under this approach you would invest heavily in well-indexed mutual funds or ETFs and would maintain this profile for most of your working life, only shifting heavily to safe assets when you’re within five to ten years of retirement.
The logic behind this alternative approach is that, historically, the stock market tends to recover losses within a period of years. Specifically, except for the Great Depression and Great Recession, over the past 100 years the stock market has taken a median 12 to 14 months to recover from strong downturns. As a result, mid-career workers who have invested in the market overall have time to recover their losses and continue gaining value before retirement.
This is not necessarily a widespread theory, but it has traction. Still, it’s important to note that this approach only works for investors who buy and hold long-term assets like index funds. It does not apply to investors who invest significantly in individual equities.
Bottom Line
How you balance stocks in your portfolio is a matter of risk tolerance and investing timeline. A good rule of thumb is to buy funds with your investment money and individual stocks with your speculation capital, and to hold more of your portfolio in stocks the longer you have to invest.
Tips for Investing
A financial advisor can help you balance a portfolio. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
If you don’t have a lot to invest or you’re just starting out, you might want to consider a robo-advisor. Robo-advisors, which are entirely online, offer lower fees and account minimums than traditional financial advisors.
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Source: https://finance.yahoo.com/news/too-many-stocks-portfolio-tell-130059865.html