Ask Colin

Is there a practical limit to the number of stocks one should buy?

Managers of huge funds have other issues, but for a small private investor, I think the considerations are these:

1. Brokerage. If you have too many positions, they will may all be so small that brokerage is too large a percentage of the amount invested. You may therefore have to make a larger percentage gain on each position before you have covered your costs. Remember you pay brokerage both on the way in and the way out. This is of far more relevance to short term traders trying to catch short moves than to investors looking to catch big moves in a longer time frame, but is not altogether unimportant.

2. Diversification Vs playing for meaningful stakes. If you have too few stocks, your risk is high, because an adverse situation on one stock can cripple your overall return on your portfolio. So, it is necessary to have a certain amount of diversification (number of stocks) to spread your risk. However, if you go too far the other way and have too many stocks, your portfolio will be like an index fund and will never do much better than the overall market and tend never to go up when the market falls. If you are trying to beat the market, you need to have fewer positions and "play for meaningful stakes" on each one as Max Gunther put it in his book The Zurich Axioms.

My own strategy, as you know, is to never initially invest less than 2% of my total funds in any one stock, but no more than 6%. This means that when all my funds are in the market, I will have a minimum of about 16 stocks and a maximum of about three times that number. Portfolio theory suggests that 8 non-correlated positions is enough to diversify away most of the risk. However, all shares are at least partly correlated (move in line with the overall market), so more than 8 is necessary.

3. Control. If you have too many stocks in your portfolio it becomes very time consuming and difficult to do a good job of monitoring them. Time constraints might mean you get careless. Even more dangerous is that if the whole portfolio is going OK, you can become lazy in cutting out the ones that break their trends. The key to investing and trading is to quickly cut the losers and ride the winners. However, the mistake most people make is not cutting the losers quickly enough and consistently enough.