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How many shares do you need for a diversified portfolio?

Holly Black  |  01 Mar 2019Text size  Decrease  Increase  |  
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Investing in a fund gives you immediate diversification, but those who prefer picking shares for themselves expose themselves to a greater risk of capital loss.

Investment funds usually have at around 50 different holdings and often upwards of 100 – unless the manager is running a particularly concentrated portfolio. Investing through a fund, even just one, gives you an element of capital protection because it is unlikely that all of the different stocks within its portfolio will rise and fall at the same time.

Achieving diversification when you are picking your own shares is rather more difficult. Building a portfolio of hundreds of shares is expensive as there are trading costs for every purchase or sale, and it’s also time-consuming if done properly.

Why stock pick?

It is easy to invest directly in company shares through a fund supermarket, just as you would invest in a fund or trust. This route often appeals to more experienced investors who are willing to do a certain level of research to pick companies and keep an eye on how they are performing.  

Investing directly may appeal for other reasons too – if you directly own shares in a business you will often be able to attend its Annual General Meeting, for example, and vote on matters affecting the company. Some shares come with perks, too, which can be a handy bonus.

Tom Stevenson, investment director at Fidelity International, says: “Investing in shares can be a fun and rewarding hobby and can feel more tangible than investing second-hand through a fund. But with thousands of listed shares, it takes time, effort and skill to research the right ones for your portfolio.”

The first thing to bear in mind, says Stevenson, is that you should be choosing shares that match your risk appetite. That means risk averse investors will likely want to steer clear of fledgling businesses whose share price movements may be more volatile. Choosing holdings that match your investment objectives is important regardless of whether you invest through funds or shares.

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Ian Forrest, investment research analyst at The Share Centre, says: “In terms of choosing companies, I tend to suggest investors start looking at those they are already familiar with, perhaps by being a customer or having some professional involvement.”

Choosing stocks in this way means you are more likely to already have a basic understanding of the business. This is also an effective method when investing in shares for younger investors who are likely to be more engaged if they own shares in a company they know and like.

Achieving diversification is important too. Having a portfolio containing just a couple of shares leaves you vulnerable in the event that one of them goes bust or its share price plunges. Investing in a range of companies across different sectors and regions should give you a smoother investment journey.

Investors will also need to familiarise themselves with a few basic terms and valuation measures such as price/earnings ratio so they can try to determine whether they are paying an attractive price for a share relative to its profits, assets or the dividend it pays. You might also want to research tools such as a stop-loss mechanism, which automatically sells an investment if it falls by a certain amount.

When to use a fund

Being properly diversified means owning different types of asset too, such as corporate bonds, government gilts and commercial property. These can often be more easily – and cheaply – accessed through a fund so it may be worth considering combining approaches within your investments, leaving certain assets to the professionals while investing directly in areas where you feel more confident.

Forrest adds: “It’s also important to note that diversification can be overdone. For most investors in individual companies, 25 is a good place to stop. As long as they are well spread across different sectors and mostly in the larger stocks, that number can provide more than enough diversification.”

Investing in any more, says Forrest, not only racks up your trading costs but risks duplication within your portfolio. If you invest in the 200 firms on the ASX, for example, you will be very exposed to the oil and mining sectors, which dominate the index.

Rob Pemberton, investment director at HMFC Wealth, adds: “You need to make sure you have the time to properly monitor your portfolio. If you don’t, something could go horribly wrong and you might not even be aware of it for several weeks.”

This may be more difficult, too, if you are investing in overseas shares. Not only do these often require extra forms to be filled in and have potentially higher trading costs, but depending on the time zone their stock market may be open while you’re asleep, which may mean you miss something important.

Stevenson says: “If all of this sounds like too much hard work or you just don’t have the time, then consider leaving the investment decisions to a fund manager who has the dedicated resources, time and skill to construct and manage a diverse portfolio of shares.”

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