Is It Better to Have a More Diversified Portfolio Even When You're Starting Small?

In this mailbag segment of the Market Foolery podcast, host Chris Hill and senior analyst Matt Argersinger weigh a question of portfolio diversification when your bankroll is still relatively small -- say, $5,000. With a no-transaction-fee platform to purchase through, an investor could in theory buy tiny stakes in many stocks as easily as bigger ones in fewer. What's the right way to go? The Fools have a clear answer.

A full transcript follows the video.

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This video was recorded on Sept. 19, 2018.

Chris Hill: Great question from Matthew Mandeville in Michigan. Matthew writes, "I've opened a Robinhood account with $5,000. With Robinhood having no transaction fees, is there any real downside to having a much more diversified portfolio with small positions in each stock, say, one to five shares, instead of fewer stocks but with larger positions? The only issues I can see are, one, it's much harder to closely follow each company; and two, with small positions, your big winners do not affect your portfolio as much. Even with these issues, it seems like having a more diversified portfolio would be better in the long run. What do you think?" Great question!

Matt Argersinger: Very great question, Matthew! I will say, the answer is yes. I think there's a tremendous amount of value to having a portfolio where you're making small investments in companies on a regular basis. I'll share a quick personal story. I recently wrote an article for to this effect. I kind of have two portfolios. I have many portfolios, but two buckets that my personal stock net worth is invested in.

One bucket is my concentrated portfolio that I pay a lot attention to. It never has more than 15 stocks in it. It has big positions. I "manage" it more regularly than I do this other bucket. The other bucket is essentially a collection of my wife and my retirement accounts. Those are 401(k)s that we have here at The Fool, for example, self-directed, and some IRAs. Essentially, we have regular money going in those accounts monthly. With those, I'd say they're almost on autopilot. Money goes in, we buy a few stocks, some of the money goes to an S&P 500 index fund. But mostly, it's just, every month, investing a few shares in few stocks.

Recently, about a month ago, I went back, and I looked at how these two buckets had performed over the last roughly 13 years since I've been keeping track. The bucket of the concentrated big positions, it's done about 12% a year, which I'm not complaining about. It's pretty good. I'm proud of that. The autopilot bucket, where I'm just buying a few shares a month, that thing's done 18% a year. I attribute that to basically the mechanical idea of putting a small amount of cash to work every month in a few stocks.

There are about 70 stocks across these retirement accounts. It's a big bucket, very diversified bucket. But what happens is, those small investments you make in some incredible winners -- like, I've got Netflix in there, for one, I've got MercadoLibre in there, I've got a few other monster companies that have done well. I've got a lot of losers in there, too. But, that bucket has just performed so well, and I pay so little attention to it. It is literally on autopilot. And this other one, where I'm spending a lot of my time, and making big stakes and doing big transactions? It's done a lot worse.

Hill: That's great. Matthew's just starting out, but he's right, particularly if you're going to take a very even-handed approach and say, "Well, I'm going to buy $500 increments of 10 companies," or something like that. Or possibly even smaller than that. The longer you let that go, the more you're going to see that, yeah, you're going to have some losers, but you're going to have a couple of winners in there that will, in short order, they will no longer be small positions.

Argersinger: No, no, no. And the beautiful thing about Robinhood is that, obviously, you're not paying transaction fees, which is a huge drag on returns. Matthew, you'll find opportunities down the road. You'll have bought a small position in a company, it's done really well. If you also do the David Gardner approach -- which is tend and water your flowers, trim your weeds down; maybe not selling, necessarily, but just focusing more capital on some of your winners in those portfolios over time, which I've also done -- you can do even better.

I'm all about the small, regular incremental investments every month, even with a few shares. I'm all about it.

Hill: One change in my investing that has happened recently is -- you just touched on this, it's the whole thing with your weeds. I was looking at my personal portfolio. Mine's with TD Ameritrade, it's been there for a long time. I'm sure others offer this service as well, where you're looking at your portfolio, and one way you can look at it is a pie chart. You've got your stocks, and you just click on this button, you can see, this is what percentage of your portfolio is tied up in this stock. I was looking at Under Armour. [laughs]

Argersinger: That slice has been shrinking.

Hill: It was like, "1% of your portfolio is in this." And I looked at that, and I just thought, "You know what? A couple of years ago, I would have looked at that and thought, I should just sell this and I should put the money elsewhere." That's where I just decided, no, I'm just going to let that go. It's not a significant part of my portfolio. I'm just going to let it go.

Argersinger: That's the beautiful thing. Under Armour, whether or not they end up turning around or not, it's a small position right now. If it drops another 50%, it's not doing much damage to your portfolio. On the other hand, if it turns around, maybe you can add to it again down the road, and all of a sudden, you have this bigger slice of your pie.

Hill: I could dare to dream that someday, it becomes 2% of my portfolio.

Argersinger: [laughs] One can dream.

Chris Hill owns shares of Under Armour (A Shares) and Under Armour (C Shares). Matthew Argersinger owns shares of MercadoLibre, Netflix, and Under Armour (C Shares). The Motley Fool owns shares of and recommends MercadoLibre, Netflix, Under Armour (A Shares), and Under Armour (C Shares). The Motley Fool has a disclosure policy.