EC Designing The Common Stock Portion Of Your Retirement Portfolio: Concentrated Or Diversified Part 3

Designing the common stock portion of your retirement portfolio is very challenging.  For starters, there is no absolutely perfect or even best way to design a stock portfolio.  However, there are many effective strategies that have produced successful long-term results.  The key to success is to find and implement the strategy that best fits your own unique goals, objectives, needs, and most importantly – risk tolerances. I cover more aspects in Part 1 and Part 2.

 Many aspects associated with designing a common stock portfolio  need to be considered.  The number of individual companies to include in your portfolio is a big one.  In addition to the number of companies, how much weight you should put in each one.  Should they be equally weighted?  In other words, should you put the exact same percentage of your portfolio in each company?  Or, does it make more sense to overweight some and underweight others?  Moreover, should you own stocks from every sector or just the ones you like the best?

These are just a few of the important questions that investors must grapple with when designing a common stock portfolio.  But most importantly, and I repeat myself, there is no absolute or perfect strategy for constructing a stock portfolio that fits every individual investor.  On the other hand, there are important considerations that every individual investor would be well advised to contemplate.  Ultimately, it comes down to designing a stock portfolio that suits you.

Therefore, my objective with this article is to provide some food for thought and common stock portfolio design ideas that I hope can help individual investors make better choices that fit and meet their own needs.  I am a big proponent of applying logic and common sense to the investing process.  Consequently, rather than just giving specific portfolio construction strategies, I also intend to offer some logical ways to look at common stock portfolio construction.

The Universal Principle: Start With a Plan

I believe that there is only one universal principle about constructing a common stock portfolio that universally applies to every investor.  Prior to building any portfolio, common stock or otherwise, it is imperative that every investor starts by developing a comprehensive and detailed plan.  Importantly, it’s not only imperative to have a plan, it’s even more vital to be disciplined about following it.

This is commonly referred to as an investment policy statement (IPS).  However, an IPS generally goes beyond defining investment goals and objectives, it also takes into consideration risk tolerance, liquidity requirements and asset allocation.  However, for the purposes of this specific article, I am simply referring to a well thought-out plan design for the common stock portion of an overall portfolio.  Therefore, my discussion will be limited to investment goals, objectives and risk tolerances.

Logically then, the first step in creating your investment plan is to clearly identify and determine your specific investment goals and needs.  For example, if your primary objective is growth or total return, your focus might be best placed on a portfolio combination of growth stocks and/or above-average growing dividend growth stocks.  In contrast, if your primary objective is current income, your focus might be best placed on a portfolio combination of blue-chip dividend paying stalwarts and/or high-yield stocks.  I covered these categories extensively in Part 1 and Part 2 of this series.

Of course, there are many variations of what the most appropriate mix of stocks might be. Therefore, depending on your needs and risk tolerances, the mix of appropriate stocks are only limited by each investor’s imagination coupled with their needs.  Once again, there is no perfectly right or wrong answer, except to design a portfolio that is capable of meeting your goals, and one that you are comfortable enough with to stay the course.

How Many Stocks Should My Portfolio Hold?

The question of how many stocks a portfolio should contain has been widely discussed, and even hotly debated.  Some of the greatest investors that ever walked the planet have shared their views and opinions, and there have been numerous academic studies conducted as well.  However, there really is no consensus, and many of the differing views are supported by compelling and logical arguments.  Interestingly, the arguments of many renowned fundamental investors versus academics that have conducted studies are not that far apart.

Therefore, instead of supporting any specific number of holdings, I have chosen to offer some practical considerations that individual investors might think about.  On the other hand, I will also share some of the views and opinions of others who have studied the subject of how many stocks to own.

The Simple and Basic Mathematics Behind How Many Stocks to Own

At the risk of being accused of stating the obvious, I believe it’s important to consider and have a clear perspective of the basic mathematics behind how many stocks you own.  In my opinion, this is important because it relates to the investor’s risk tolerance.  Additionally, it also relates to the potential rate of return a portfolio can achieve.  So let’s look at some basic numbers.

For starters, let’s assume that you are constructing an equal weighted portfolio.  This simply means placing the same amount of your investment in each selection.  Therefore, the number of stocks you place in a portfolio represents the percentage of your portfolio it comprises.  The basic math is simple.  If you hold 5 stocks, they each comprise 20% of your portfolio.  If you hold 10 stocks, they each comprise 10%.  If you hold 20 stocks, they each represent 5%.  If you hold 25 stocks, they each represent 4%, and so on.