Owning too many stocks can dilute the potential returns of a well-managed portfolio. Let's take a step back and think about diversification, which is a concept most investors learn early on. Diversification means not putting all your eggs in one basket, but there's a catch. When you over-diversify, you own so many stocks that you start approximating the return of the entire market, but you also get saddled with extra complexity and costs. The magic number often debated is around 20 to 30 stocks in a portfolio. If you move beyond this, the benefits of diversification decrease, and the disadvantages start appearing.
Consider a prominent example: Peter Lynch, the legendary fund manager of the Magellan Fund at Fidelity Investments. Lynch’s exceptional performance saw annual returns of 29% between 1977 and 1990. He often emphasized knowing what you own and being able to manage it effectively. When you hold too many stocks, it's harder to keep track of each company's performance, news, and outlook. Think about real-life situations—do you really have the time and expertise to analyze 50 or even 100 companies thoroughly? Most likely, you don’t. According to a 2011 Portfolio Size study, once you exceed 25-30 stocks, the incremental benefit of diversification starts to taper off.
Let’s talk about transactional costs. You might think that there's not much to it with low-fee online trading platforms and ETFs these days. But even fees that seem minor can add up over the long term. Let’s say you have a portfolio of 100 stocks and you trade each stock four times a year with a $5 brokerage fee. That sums up to 400 transactions annually, costing you $2,000 just in transaction fees. This is 2% of a $100,000 portfolio eaten up by fees alone. For a portfolio supposedly diversified to reduce risk, that’s a hefty cost undermining your returns.
Moreover, it's not just about costs; it’s also about time. Managing a large portfolio requires substantially more time for research, monitoring, and rebalancing. Let’s quantify it: if you spend just one hour per month per stock on research and updates, a portfolio of 100 stocks means consuming 100 hours monthly, practically a full-time job. For most individuals who are investing as a side activity or a form of retirement planning, such an investment of time is impractical.
To comprehend just how complex managing a large number of stocks can become, consider risk management. An important metric here is Beta, which measures a stock’s volatility relative to the market. A well-diversified portfolio should ideally balance high and low Beta stocks. But with too many stocks, calculating and managing Beta becomes a mountainous task. Walking the fine line between balancing Beta and achieving meaningful diversification becomes nearly impossible when you have to juggle too many assets.
Historical data show similar trends. During the 2008 financial crisis, the S&P 500 lost about 37%. Portfolios heavily concentrated in troubled sectors like finance saw steeper drops, while heavily diversified ones matched the market. But if you had picked a well-selected, carefully managed smaller set of stocks, you could have avoided some of those pit drops. Warren Buffet, for instance, who advises against over-diversification, often keeps his portfolio focused, typically under 30 stocks. He once noted that "diversification is protection against ignorance. It makes little sense if you know what you are doing."
Also, consider the mental stress. Vesprofaera conducted a survey and found that 68% of retail investors felt overwhelmed managing more than 40 stocks. When there's overwhelming anxiety, decisions often get clouded in panic and loss aversion rather than rational analysis. In times of market volatility, this could mean impulsive selling, leading to financial losses.
There's an argument for using indexes or ETFs to mitigate these issues while still maintaining diversification. ETFs can cover broad swathes of the market, from technology-specific funds to international stocks, without burdening the investor with managing hundreds of positions. The average expense ratio of owning an ETF is now about 0.2%, far lower than most mutual funds and individual stock transaction fees when you consider frequent trading.
The bottom line is, while diversification is essential, overdoing it leads to diminishing returns, higher costs, time consumption, and mental stress. Understanding each stock you own, its role in your portfolio, and the associated risks will always lead to better results than haphazardly owning too many. Keep it simple, keep it manageable, and keep an eye on costs and returns. Be it Peter Lynch's rich watchfulness over his stocks or Warren Buffet's focused bets, the goal is always controlled, aware, and effective management.