2 Stocks Does Not a Diversified Portfolio Make

By Markets Fool.com

In this segment of Motley Fool Answers, Alison Southwick, Robert Brokamp, and Ron Gross discuss the right way to add breadth to a thin portfolio -- which, it turns out, has a lot to do with how large your portfolio is when you realize you're too reliant on a small number of holdings. But of course, one strategy they always like is to buy index funds.

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A full transcript follows the video.

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This podcast was recorded on Aug. 30, 2016.

Alison Southwick: It's time for Answers, Answers, and today's question comes from Bud. Bud writes: "About a year ago, I put some money into the market but only purchased two stocks,AppleandUnder Armour. Consequently, now that I realize the error of my ways by ignoring the principle of diversification, I'm wondering if you think I should sell a portion of my two previous purchases in order to purchase other companies, thus more favorably rounding out my modest portfolio. Or should I just stay put and make other purchases down the road as I'm capable? I'm definitely a buy-and-hold kind of guy." Well, that's our kind of guy.

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Ron Gross:Absolutely.

Robert Brokamp:Our kind of guy. Well, Bud, it depends on how much of your net worth you put into it. So if you had a $500,000 401(k) and you split it between two companies, I'd say yeah, you should probably sell a little bit and diversify a little bit more. But if you're a new investor, and you're just getting into the market with a few hundred dollars, maybe a thousand dollars, I think it's probably fine. I've mentioned in previous episodes that I think it's still a good idea for a new investor to still have an index fund somewhere, so you could add that to it. But I'm also going to turn to Ron, our expert, and get his thoughts on this. So with...

Gross:The word "expert" always worries me.

Brokamp:So when someone is starting out investing, what do you generally recommend? Do you recommend they just buy one or two stocks, or do you think they should jump in with a few more?

Gross:So obviously, you have to start somewhere, and I love the idea of starting with an index fund, because you get instant diversification. If you buy, whether it's an index mutual fund or an index ETF like the S&P SPDRs, SPY, all of a sudden, you own a tiny piece of 500 companies, and you're nicely diversified. And then you can get into your lifetime of investing into individual companies.

One, two, three, try to get to 15, we like to say. We say that usually, even if you don't have an index fund, because that's when diversification even becomes more important. If you own an index fund, it becomes perhaps less important, but I like the number 15. David Gardner, here at the Fool, always likes to quote that number.

One thing I think you should be careful of, though, as you start investing in individual stocks, is the amount of capital you're going to put into each company and the amount of commissions you pay. So I wouldn't recommend buying $100 worth of stock and paying a $9.99 commission, because that percent is way too high. You'll have to make 10% on that stock just to break even. So try to keep your commissions to under 2%, we like to say -- the lower, the better, so you're not fighting against those commissions before you even get started.

Brokamp:So, Bud, I hope that helps. Unless these two investments are a huge component of your net worth, I think it's fine to hold on to them, but with additional investments. Try to get a little bit more diversification.

Ron Gross owns shares of Apple. The Motley Fool owns shares of and recommends Apple and Under Armour (A and C shares). The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.