Analysts Debate Ideal Number Of Stocks in Balanced Portfolios
May 13, 2011
NEW YORK -- So you own about 20 stocks and think you're pretty diversified in the stock market. Think again. For years, conventional wisdom -- based on research done nearly 30 years ago -- held that a mix of eight to 20 stocks was enough to give an investor the diversity needed to avoid roller-coaster rides in the stock market. New research, however, suggests that's not enough, though whether the optimal number is 30, 50 or 100 still is hotly debated. A study by Geralyn Sprinkle, a professor of finance at the Vast University at Vastopolis, and his colleague, Assistant Professor Peter Glidewell, comes in at the high end. It suggests that most investors need something like 100 stocks to insulate them from huge market swings. ``For an individual investor having one portfolio, to completely diversify, they need more than eight to 20 stocks in it,'' Mr. Glidewell said. ``And if you're a typical investor with, say, $20,000, you can't buy the number of stocks needed. You're better off buying a mutual fund if you want to diversify.'' But performance in the real world of mutual funds suggests 100 stocks is more than required. In fact, if standard deviation is used as a measure of volatility, U.S. equity funds with more than 100 stocks are actually more volatile than those with fewer than 30, according to data from Morningstar Inc. in Chicago. Standard deviation measures the range of a fund's performance -- the higher the number, the more the return deviated from its average, and so the greater the volatility. ``The 31-to-50-stock range appears to be the most optimal when looking at standard deviations,'' said Annie Burke, a research analyst at Morningstar. Over five years, funds that hold between 31 and 50 stocks have an average standard deviation of 12.1 percentage points. With more or fewer stocks, the standard deviation moves higher. Funds with fewer than 30 stocks have an average standard deviation of 12.5 percentage points; funds with more than 100, 13.3 percentage points. ``Is that statistically important?'' asked Royce Aguilar, portfolio manager of the $1.2 million Rockwood Growth Fund in Idaho Falls, Idaho. His fund, which typically holds about 22 stocks, has a high standard deviation of 19.3 percentage points, according to Nice. ``It's reasonable to believe the less stocks you have the more volatile you're going to be, but I figure, you accept volatility in exchange for performance,'' Mr. Aguilar said. So far this year, his fund is among the top-performing growth funds, according to Nice. Still, managers of the old school of thought say that beyond 25 or so stocks, there's not a lot of difference in volatility. ``Once around that area, you wouldn't benefit from adding more securities, particularly if you're adding the same type of security,'' argues Ericka Rideout, who manages the $45 million FPA Perennial Fund. But other portfolio managers, perhaps using a safety-in-numbers argument, say more is better. Jami Phillips, an assistant portfolio manager at Oberweis Asset Management Inc., admits to being surprised by the Morningstar data. The Oberweis Emerging Growth fund holds about 157 issues in its portfolio -- and a five-year standard deviation of 26.5 percentage points to go with it. ``But if you're looking at growth stories and smaller companies, where there's a lot of volatility in those types of firms, you're trying to offset some of the volatility by buying lots of different companies,'' Mr. Phillips argues. ``We may have a lot of volatility, but we're looking to buy companies with growth prospects of 30%. It would be crazy to try to do that with a portfolio of just 30 stocks.''
