Conventional wisdom dictates that an investment portfolio should be diversified.

Your attention may be drawn to the portfolios of two of the world’s greatest investors. Peter Lynch held 1400 stocks in his Magellan portfolio. Shelby Davis held over 1200 stocks at the time of his death.

On the other hand, in ‘Common Stocks and Uncommon Profits’ Philip Fisher states, ‘Investors have been so oversold on diversification that fear of having too many eggs in one basket has caused them to put far too little into companies they thoroughly know and far too much in others about which they know nothing at all’.

So which approach is right for you? The highly diversified 1000+ stock portfolio of Lynch or Davis, or the more concentrated approach favoured by Fisher?

For an investor with modest goals who makes a small monthly contribution into index funds, spreading the risk over geographical areas and industry types makes perfect sense.

But if you are looking to make 20% plus annual returns, a more focussed approach is required. Although Davis and Lynch appeared to favour portfolios with a large number of stocks, a more detailed look at their habits reveals a different picture.

Shelby Davis may have had over 1,200 stocks when he finished, but that was not how he made the bulk of his fortune. With $50,000 cash, he started in 1948 with a portfolio of seven insurance stocks. He took his net worth to $234,790 by the end of his first year. By the mid 1950s he had rotated into 32 long-term insurance holdings, increasing his wealth to $1.6 Million. By the end of the decade his net worth had reached $8-10 Million.

For the vast majority of his investing career Davis’s portfolio contained 30 to 50 stocks. His investing style departed from this only in his very late years, as his faculties waned and his investing performance deteriorated.

Peter Lynch’s fund held 1400 stocks, but that didn’t reflect his approach to investing. He explained it like this. ‘a foolish diversity is the hobgoblin of small investors… I’d be comfortable owning between three and ten stocks’.

He also added, ‘Although I own 1,400 stocks in all, half of my fund’s assets are invested in 100 stocks and two thirds in 200 stocks’. The smallest 500 companies made up just 1% of his fund.

As the manager of a large fund, Lynch was much more constrained than the individual investor. If he had invested in only ten stocks the size of any one position might equate to a huge percentage of all the shares of that company.

On leaving Magellan and becoming responsible for his personal investments, Lynch writes, ‘You may be wondering what’s happened to my investing habits since I left Magellan. Instead of following thousands of companies now I follow maybe fifty’.

Tom Gayner, the highly respected investment manager at Markel holds a portfolio of just over 100 stocks, but 74% of the amount invested is in just 30.

Of the twelve successful investors studied by Guy Thomas, nine of the twelve had portfolios of fewer than fifty investments and of those nine, six had portfolios of fewer than ten investments.

The Oracle of Omaha, Warren Buffett, has 47 stocks in the Berkshire Hathaway portfolio. For a portfolio of $108 Billion, that’s not a huge number!

In conclusion, it seems that most highly successful investors have concentrated portfolios. Institutional investors may sometimes have to have larger portfolios, but even these will commit the majority of their funds to no more than 100 stocks.

As we shall discover throughout this book, there is no single prescription to suit every investor, but a portfolio size of around fifteen to twenty stocks would be appropriate for most. A portfolio of six stocks would seem to be the lowest, reasonable limit if you like concentration. A maximum portfolio size of around fifty stocks would be an appropriate upper limit if you have the time and inclination to understand that number of businesses.

Next Topic: Investing Style