I recently read a blog post on investment basecamp blog that addressed this question. We all know and have heard diversification is the best method to minimize risk in the stock market. Some say diversify across all asset classes including commodities and currencies. According to the basecamp article the academics say that 90% of maximum diversity is obtained by owning a portfolio of 12- 18 stocks. Benjamin Graham recommend 5-25 stocks with each company being large, prominent and conservatively financed. John Keynes recommends 3-5 stocks that you know well and in the management of which one thoroughly believes. Warren Buffett says 5 to 10 stocks If you are able to understand business economics and able to find sensibly-priced companies that possess important long-term competitive advantages. If not Buffett is actually a big fan of indexing and Seth Klarman recommends 10 to 20 stocks that you know very well.
I recently finished Robert Kiyosaki’s book Rich Dad Poor Dad, where he states his sock market investments mainly composed of small cap growth stocks and he stated out of 10 stocks there would be 2 winners, 4 with no gains and 4 losers, but the winners made up for the losers. Investing in individual stocks no matter how many you own will have a similar outcome. You will pick some winners and some losers. The goal is to have more winners than losers and have the winers win bigger than the losers lose.
To sum up what all the experts above are saying is that if you are playing the stock picking game, buy a handful of stocks whether its 20, 30 or 100. Make sure you know the companies well and are able understand the business model and economics and then wait to see which ones will be your winners and which ones will be your losers.
If, on the other hand, you are not adept at understanding the ins and outs of business and are not able to read business statements and prospectuses well or if you are not confident enough about which companies will be winners to steak all of your retirement funds on, then index fund investing is a very good option.
Some will argue that they can beat the market by buying individual stocks and this is possible, but difficult to do. I can understand needing to beat the market in some situations where time is not on your side, but if you start early, getting rich slowly and accepting the 7% average return of the market will get you a substantial retirement portfolio.
Some don’t like the auto investing or the set it and forget method of index fund investing. Even the White Coat Investors Dr. Jim Dahle says investing should be boring and not exciting, but that’s not always the case. Most of the FI minded community choose total stock market index funds and I too am a fan of them. The asset allocation of most total market index funds includes 80% large cap US stocks, 15% Mid Cap US stocks, 4% small cap and 1% micro caps US Stocks. They are blended stocks with equal weight in growth and value stocks.
If you want to spice things up you can add in some international index funds and even add more micro cap value index funds for some excitement and additional exposure in your 401K. I definitely have. And if you’re young you can even bare it all and go nude with 100% stocks and loose the protection of bonds. As you approach retirement age you can cover up with some bonds for decency and common curtesy.