I’ve explained here why we should really consider direct investing (as opposed to investing in mutual funds) if we have a sizable sum of money to invest. But herein lies an interesting question? How much do we need before we can consider going down the direct investing route? Well, if we only have, say, US$5,000, then that obviously won’t be enough, and we’ll have to put our money into a mutual fund. But what about US$100,000? Is that enough? And why?
The answer to this question relates to how many stocks we need to have in our portfolio. Obviously if we only have a few stocks in our portfolio, and something bad happens to one of the stocks, then we will be stuffed. That is why we need to diversify – to eliminate the specific risk of investing in stocks. But while we can significantly reduce the specific risk of investing in stocks, we cannot do anything about the systemic risk – if the market goes down, our stocks are sure to follow.
So how many stocks do we need to remove - or significantly reduce - the specific risk? Well, there is no single answer to that question. The general consensus is at least 15 and probably more. I’d say at least 20. With 20 stocks in your portfolio, each stock will only represent 5% of your total portfolio. So if anything bad happens to one of your stocks, the overall impact on you investments will be limited.
Besides having at least 20 stocks in your portfolio, I also wouldn’t have any more than 30. Any more than 30 stocks and you’ll probably find it difficult keeping track of them. And you won’t get any more benefits from diversification by having more than 30 stocks. At this number, each stock will only represent around 3 percent of your total portfolio.
As there are transaction costs involved in investing, I wouldn’t consider investing less than say, US$10,000, in each stock. So to have a portfolio of 20 stocks, you will need to have capital of around US$200,000. For 30 stocks you’ll need around US$300,000.
Picking the stocks
Ah, this is where it gets tricky of course! It’s unlikely you will have a crystal ball so it is difficult to know which companies will do well and which ones won’t. Even so there are some things you should remember:
1) To get a well diversified portfolio, you need to invest in stocks from different sectors: financial, property, telecommunications, consumer goods, manufacturing, etc.
2) Choose established and profitable companies with good brands. i.e. blue chips. These companies are likely to still be around in 10 years time!
3) Avoid small companies. Some may have huge potential and may make you a millionaire but it is a gamble unlikely to come off. If you have a portfolio of 20 to 30 stocks, you could choose one or two small companies - provided you are aware that you could potentially lose your entire investment in those stocks in the worst case scenario.
4) To achieve further diversification, considering having a few ETFs in your portfolio. These will allow you to invest in high growth economies such as India, China and Indonesia.