A sound principle of stock investing is to spread your portfolio around different companies.
What if you don't? You face the danger that if something bad happens to your single investment, you have virtually no way to cushion the blow.
Fair enough, but exactly how many stocks should you own? A dozen? 50? 150? The answer is typically fewer than the number of fingers on your hands.
There's a fallacy in managing a portfolio that contains dozens of stocks: While your exposure to risk in individual stocks is smaller, you are also forfeiting the chance to make substantial profits in the big winners. The reason is simple: You won't have enough shares to enjoy productive gains.
Another drawback of an over-diversified portfolio is that it takes a lot of work to watch over dozens of companies, tracking their performance, earnings reports and other developments. With a smaller number of holdings, it's easier to stay on top of the companies you own.
Fewer Is Better
"The big money is made by concentration, provided you use sound buy and sell rules along with realistic general market rules," IBD founder and Chairman William J. O'Neil wrote in his landmark book, "How to Make Money in Stocks."
O'Neil's guidelines for individual investors break down like this:
For a beginning portfolio of about $3,000, just two stocks are sufficient.
For a portfolio of $5,000 to $20,000, three stocks can be a manageable load.
For accounts up to $200,000, four or five stocks are enough.
Even those who have more than a million dollars to invest should limit themselves to six or seven stocks.
Of course, to have success with a handful of stocks, you have to make the correct picks. This doesn't mean you have to luck out with fantastic choices.
A careful process of selecting companies with superior profit and sales growth, profit margins and market-leading products should narrow down the field for you pretty quickly. Deduct the stocks lacking good chart profiles, and you end up with an even more refined (and shorter) list of potential investments.
Don't trust yourself to do this? One option: Turn to the IBD Sector Leaders, those few elite companies that are highlighted at the top of some sectors in the IBD NYSE + Nasdaq Smart Tables, today starting on Page B3. Another option: Utilize IBD Leaderboard.
Stocks from these features have a potent blend of fundamentals, and as a group they have performed well above the S&P 500. Analysis of their charts, written by IBD market writers, can guide you on when to buy.
No doubt, a better stock than any that you own will come along and tempt you. If you are convinced about buying it, then sell one stock that's not performing as well as your others to make room on your portfolio.
Remember, there will be times when the right number of stocks to own is zero. When the general market goes into a correction or bear market, no degree of diversification can protect you adequately from losses. This is particularly true of growth stocks, which can generate superior returns, but tend to fall more during weak markets. Use IBD Market Pulse, published with the Big Picture every day, to guide you.
