What is the right amount of stocks an investor should have in his/her portfolio to achieve diversification? Is it 10? Is it 20? Is it 100?
I currently believe that the right level of diversification is different for each investor. Some investors have an investment process and psyche that suits a highly concentrated portfolio, say, of 10 companies or less. I know I do not belong in this group. I am well-suited for a portfolio that has significantly more companies.
When I was investing for my family, the portfolio had slightly more than 50 companies by the time I liquidated most of its stocks in June 2020 so that the capital could be invested in an investment fund I’m currently running with Jeremy. I was comfortable managing around 50 companies and I could sleep soundly at night.
Why do I say that the right level of diversification is different for each investor? Let’s consider the case of three legendary US-based investors.
First there’s Peter Lynch, the manager of the Fidelity Magellan Fund from 1977 to 1990. During his tenure, he produced a jaw-dropping annual return of 29%, nearly double what the S&P 500 did. Toward the end of Lynch’s stint, the Magellan Fund owned more than 1,400 stocks in its portfolio.
Then there’s Walter Schloss, who produced an astonishing return of 15.3% per year from 1956 to 2000; in comparison, the S&P 500’s annualised gain was a little below 11.5%. Schloss typically held around 100 stocks in his portfolio at any given time.
The third investor is Charlie Munger, who achieved an annual return of 13.7% per year when he was managing an investment fund from 1962 to 1975. Over the same period, the Dow was up by just 5.0% per year. At any point in time, Munger’s portfolio would only have a handful of stocks.
Lynch, Schloss, and Munger are all stock market investors with incredible long-term track records (and I consider all of them as my investment heroes!). But their levels of diversification are so different. I think this is the best example of how there’s no magic number when it comes to diversification. You have to first understand your own temperament before you can know what’s the right level of diversification, for you.
Note: An earlier version of this article was published at The Good Investors, a personal blog run by our friends.
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Disclosure: Ser Jing does not own shares in any of the companies mentioned.