Adding new holdings to your portfolio can be deceptively easy. If you think you have identified a compelling story, from a seemingly oversold stock to a promising new fund, you can deploy cash into it via an investment platform in a matter of minutes. And while this is undeniably an exciting part of DIY investing, it also comes with serious pitfalls.
The ease with which you can make individual investments on a standalone basis, and sometimes on impulse, can mean that investors end up with far too many holdings.
“This is the most common mistake investors make,” says Rob Morgan, pensions and investments analyst at Charles Stanley. “I have sometimes been guilty of it myself in terms of taking a ‘pick and mix’ or ‘stamp collection’ mentality to building up an unstructured array of holdings.”
Having a sprawling list of investments can have serious consequences. Large portfolios can be unwieldy and difficult to monitor, with many positions that are too small to have a meaningful effect on their overall performance. You may also lose track of your reasons for holding a particular investment.
If you hold too many active funds that invest in the same area, meanwhile, you can rack up numerous investment management fees while only building up broad exposure to one underlying market, creating what can be described as an expensive tracker.
And after a certain point adding holdings has less diversification benefits. Burton Malkiel, an American economist, argued that although adding holdings to an equity portfolio can notably reduce volatility, the benefits of doing this begin to tail off if you have more than 20 holdings.
Over-diversification is an issue that commonly crops up in Investors Chronicle Portfolio Clinics. However, many investors also have too few holdings or a portfolio with insufficient diversification.
The right number of holdings for you depends on a number of factors such as your resources, general approach, and whether they are direct equity holdings, active funds, passive funds, or a mixture of all three. So it is worth trying to keep your number of holdings within a set range while applying certain rules to your investment process.
A numbers game
Some broad rules apply when it comes to how many holdings a balanced portfolio should contain.
Specialists argue that a portfolio consisting purely of active funds dedicated to different regions or asset classes could have somewhere between 10 and 25 holdings. Your number of holdings could be lower if you hold tracker funds, given their broad reach, with the same logic applying to well-diversified multi-asset funds. Even an equity fund that describes itself as "concentrated" normally has at least 25 holdings. Bond funds, and those that invest in riskier areas such as small-cap equities, can sometimes have more than 100 positions.
The ideal number of equity holdings in your portfolio could – arguably – be higher, because of the greater risk involved. And the consensus tends to settle on a higher number than the 20 holdings suggested by Mr Malkiel.
David Miller, investment director at Quilter Cheviot, believes that a global equity portfolio could have between 45 and 50 stocks, depending on market conditions. But – crucially – private investors need to be able to monitor all the stocks they hold.
“For individual shares there clearly needs to be more diversification than with funds – 30 to 40 holdings wouldn’t be considered too many,” adds Mr Morgan. “But you need to be more hands on and committed to monitoring.”
A slightly different way of viewing this is by having minimum and maximum position sizes, which can rise depending on the breadth of an exposure offered by an individual holding. A position of any kind should make up at least a few per cent of your allocation so that it has a meaningful effect on your portfolio's overall performance. However, hefty weightings to riskier holdings are unwise.
Matthew Lewis, chartered financial planner at EQ Investors, says that a 10 per cent position in one direct share holding “would jump out as a warning sign that further diversification is needed”. But more leeway can be applied to funds because of their broad scope.
“There’s little point investing less than 5 per cent in a fund or else it will have little impact on the portfolio,” adds Justin Modray, director of Candid Financial Advice. “I would also be wary about investing more than 10 per cent in a single fund, although it might be practical to relax this for global stock market tracking funds which tend to be reasonably well diversified by nature.”
The best approach
It can be useful to have the rough number of holdings you intend to have in mind. But rather than looking to stick to an arbitrary number, you may find it easier to initially focus on building a diversified portfolio that meets your requirements, as denoted by different "buckets" or thematic categories. This approach could take various forms, especially if you mainly invest in funds that tend to focus on specific regions, themes or asset classes.
You could take a traditional asset allocation approach, building up exposure to major equity regions such as the UK, US, Europe, Japan, emerging markets and Asia, while also using diversifying asset classes. This could be limited to the likes of government bonds and gold, or also include infrastructure, property and other alternatives. Your risk appetite will dictate how much you allocate to each asset. A mixture of 80 per cent in equities and 20 per cent in diversifiers may, for example, suit an investor with a stomach for risk and a long time in which to ride out the ups and downs of markets.
A similar approach that could work well with a portfolio of funds is a core/satellite strategy. 'Core' holdings give broad exposure to the main markets, such as global equities, in line with your risk appetite. And satellite holdings should boost your growth or income prospects but do create a higher level of uncertainty. These could include smaller companies funds, higher-yielding bonds, specialist sector funds and thematic investments. Because satellite investments can sometimes be more short term and carry bigger risks, you need to monitor these more closely.
“You can have some evergreen stalwarts that are constant features of your portfolio [in your core],” says Mr Morgan. “These could be trusted multi-asset funds such as Personal Assets Trust (PNL) or RIT Capital Partners (RCP) and a low-cost global equity tracker, alongside some more tactical investments which are perhaps kept for a shorter period.”
However not all investment professionals are convinced by the merits of taking a core/satellite approach just now. Mr Miller argues that picking good satellite positions may be difficult amid the current uncertainty. He instead recommends that investors focus on an “offence and defence” approach, with a mixture of investments that provide growth or income, and ones that provide diversification away from the equity market.
Growth and diversification categories could also apply to equity holdings. But defining a stock's role is generally much harder than identifying the theme behind a fund. Amazon (US:AMZN), for example, could be a play on a variety of themes from the rise of big tech to growth in consumer spending. So it is worth thinking carefully about why you hold an individual stock and how it fits in with your investment objectives.
With all of these approaches it is important to consider the risk that you might replicate existing positions or exposures, and reduce your level of diversification.
This can be a problem for core/satellite investors in particular. Global equity funds often have significant exposure to US stocks, meaning that you are likely to double up both on the latter market and the likes of large tech stocks such as Facebook (US:FB), Amazon, Apple (US:AAPL), Netflix (US:NFLX) and Alphabet (US:GOOGL).
Combining global bond funds or multi-asset funds with satellite holdings can bring similar risks. This is also a problem with any approach that involves buying both a fund that tracks a regional index, such as the FTSE All-Share, and a smaller companies fund that invests in the same market. The FTSE All-Share index, for example, includes FTSE 250 stocks so building up exposure to both could involve duplication, especially for investors who hold passive funds.
Stick to the rules
You also need to run a portfolio small enough that you can keep track of it. Ben Kumar, senior investment strategist at Seven Investment Management, says: “Diversify up to the point that it’s practical. You want a position to be meaningful and to be able to research it.”
Discipline and habit can help here. Mr Kumar suggests always making a note of why you are investing in a particular stock or fund at the time you do it, so you can assess the extent to which it is fulfilling its purpose in future. This mitigates the risk of buying something on a whim and then, years later, having no way of assessing its merits.
“A good rule is to always know why you bought something and to write this down,” he says.
You could also review your portfolio at least once a year to see if each holding still justifies its place, and adopt a 'one in, one out' policy for new investments when your holdings have reached a certain number.
However, these processes go against many investors' natural tendencies. People generally tend to enjoy making new investments and feel uncomfortable about selling existing ones. It can also be difficult to find the motivation to review every holding in a portfolio each year.
John Stirling, director at Walden Capital, believes that investors who find portfolio construction tedious or difficult should, instead, outsource it. “If you don’t enjoy it, don’t do it,” he says. “There are a lot of really good investment management and advisory firms who could deploy your money efficiently and effectively in line with your philosophy. If doing it yourself is more stress than fun, don’t do it.”
There are many routes to a low-stress portfolio. You could, for example, combine global equity and bond trackers, or choose a low-cost multi-asset fund. And a variation of the 'core/satellite' approach could suit you if you enjoy some elements of investing, but have little time or patience for a systematic approach.
“I tell people to put the bulk of their money into a diversified fund run by professionals and then [separately] build the basket of things they want,” suggests Mr Kumar. “If you have a diversified core you can do what you want with the little bits around the edges. That’s where people have fun.”
Rules to follow when you build a portfolio
- Consider the markets or investment types – eg, growth, income, diversification – that you want exposure to, and define holdings by these categories.
- Limit your number of holdings to what you can realistically monitor.
- Prevent riskier holdings, such as direct share holdings and funds that invest in especially volatile areas, from becoming very large positions.
- Write down your rationale for each investment and go back to this when you review your portfolio at future points.
- Outsource the 'core' of your portfolio to broad funds, such as multi-asset or global trackers, if monitoring all your holdings proves too difficult.