How many stocks is too many? | Economic Times

Arriving at a right sized portfolio is the most important task in equity investing. However, some investors tend to keep buying stocks based on tips, never sell them and end up with bloated portfolios. Another set of investors hold only a few stocks and run the risk of having a concentrated portfolio. A concentrated portfolio is also the fallout for those who buy stocks only as part of their employee stock options (Esops)—the holding is restricted to a few companies they have worked in. Some inherit a few stocks and land with a concentrated portfolio if they don’t add more stocks to their portfolio.Though both bloated and concentrated portfolios are bad, experts say risk is much higher with concentrated portfolios. The risk or standard deviation comes down with addition of new stocks. “Different sectors and themes perform in different time periods and therefore, people with concentrated portfolios will lose out of the moves in other sectors and themes,” says Ankur Maheshwari, CEO, Equirus Wealth Management.Risks associated with concentrated portfolios are very high now because the stock market and its valuations are at elevated levels. “While one can allow higher weights in trading portfolios, the thumb rule for long term portfolios is that one stock should not have more than 10% weightage,” says Dinesh Rohira, Founder & CEO, 5nance.com. Since it is not practical to have 10% each in all stocks, a well diversified portfolio will have more number of stocks. “Ideally, a well diversified portfolio should comprise 15-20 stocks,” says Maheshwari.So how does one create a well diversified portfolio? Chasing historical returns— stocks that have done well in the recent past—is the main mistake many stock investors make. You should evaluate how these stocks can do in the future instead of concentrating on past performance. Since tips based investing will get you into trouble, you should select stocks based on your own analysis. The first thing is to gather knowledge about a company you are planning to invest in and the sector it belongs to. “It is better to avoid a stock if you do not understand the company and its sector,” says Rohira.15-20 stocks are enough to create a well diversified portfolio 81481780The next step is to study the growth prospects of the company. Don’t ignore macro indicators and sectoral conditions because most stocks within a sector usually move together in the short to medium term. For example, fortunes of pharma companies were down earlier, but have changed following the pandemic. Similarly, banking and NBFCs were reeling under pressure recently due to NPA issues, but they have started bouncing back. Since sectoral fortunes keep rotating, concentrate on sectors that are expected to do well in the next two to three years. Next, study the valuation of the company and the sector.Also read: Too much diversification can hurt your wealthInherited stocksWhile it is easy to create a fresh well diversified portfolio, how should one treat th0e stocks that are inherited? The confusion increases because the family may be holding it for decades and these companies also might have done well in the past. So, the first question most people will ask is whether to sell this family gold? “Inherited stocks are not family gold and people should not treat it like that. Instead of taking an emotional call, they should take an objective call and decide solely on the basis of its future growth potential,” says Rohira. In other words, sell and shift to other stocks if any of the three criteria mentioned above—you understand the company and its sector, the company and sector is expected to grow well in the next 2-3 years and they are valued reasonably— are not satisfied.Stocks through EsopsWhile there should not be any special treatment accorded to inherited stocks, experts say that investors need to treat the stocks acquired through Esops differently. “Being an insider, an employee will be better equipped to assess the sector dynamics and also the company management’s quality and vision than an outsider and therefore, treat Esops as a separate case,” says Amit Kachroo, Managing Partner, Aaneev Wealth. That means employees of great companies like Infosys, HDFC Bank, etc can continue to hold on to them. Employees of other companies can also hold on, provided they are satisfied with what their management is doing.However, this doesn’t mean that they should not diversify their stock portfolio by adding other stocks. “While holding and enjoying the ride of Esop stocks, it makes sense to book partial profit and invest the same in other stocks,” says Kachroo. If you decide to diversify, how much should be the weight given to Esop stocks? “Since an employee will have the privilege to know the firm much better than other companies, it makes sense to give higher weight to Esop stocks,” says Maheshwari. While 10% weight limit per stock is the thumb rule, same can be increased to 20%-25% in case of Esop stocks.