Stock-picking comes with its fair share of risks, but by taking some risk-mitigating steps -- like diversifying well and staying in for the long-term -- investors can get exposed to huge gains without losing too much. In this clip from Industry Focus: Healthcare, market analysts share why they like individual stock-picking over indexes, give some advice for diversifying your portfolio of stocks, and look into some sector-specific risks in oil and healthcare.
A full transcript follows the video.
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This video was recorded on Oct. 25, 2017.
Kristine Harjes: Let's talk specifically about stocks. The sector of your broader wealth that you decide should be devoted to stocks, how do you diversify that, and how many stocks must you own in order to feel like you're diversified? What are your thoughts there?
Todd Campbell: There have been a lot of studies that have been done that talk about the right amount of stocks. I'm a stock-picker, so most of my money is in individual stocks. What I've discovered is, if you're managing a very large pool of money -- for example, let's say you're a portfolio manager managing billions of dollars, then you're going to want to own 50-plus stocks. You almost have to, just because you have so much money under management, and if you try to own a small number of stocks, you would own 20% of each one of the float of those stocks. You just couldn't conceivably do it. For individual investors, I think the sweet spot tends to come down to that 15-20. You get much beyond that, and I think there's been research that's been done that says that, as humans, we can only handle so many things at once. And I think once you get beyond into those double digits, your ability to handle those things really starts to fall off. So if you have a portfolio of 50 in your stocks, and you're trying to manage that yourself as an individual, plus work full-time, you're probably going to miss some things along the way.
Harjes: Yeah, it's putting a lot of work on yourself to keep up with every single one of those 50 different companies. There are also going to be a ton of transaction fees associated with buying and maintaining reasonable amounts of all of these different stocks that are going on. I'll also add that if you have too many stocks, you're probably just going to revert to the mean. What I mean by that is, if you're so diversified that you own 200 different stocks, you might as well just own some sort of S&P-tracking index fund, and you'll basically get the same in return without the hassle of having to keep up with all those companies and considering yourself a part business owner, because that's what you are as a shareholder, and you won't have the transaction fees of having to buy them each individually. I also will point out that too few stocks is also a problem. You don't want to have under that 15 full amount, just because a single failure at that point -- if you only own, say, five stocks, and one of them goes completely under, you're losing out on a very sizable amount of your wealth. Particularly if you have a lot of your total net worth in stocks, that can be really devastating. That sort of risk will absolutely keep you up at night.
Campbell: Keep you up at night, and potentially cause some very big long-term damage to your portfolio value. We see this in healthcare all the time, when we're talking about biotechnology. It's boom or bust. If you have a clinical-stage biotech, and you own three of them in your portfolio and that's all you own, one goes south on you and you've just taken a huge, huge hit. But you also see that in other sectors and industries as well. Oil and gas has had its fair share of companies that have ended up in bankruptcy as well. Technology, some of the smaller technology companies, they flame out relatively quickly. So, I think that while the temptation is to try and strike it rich with a big swing, you have to remember that oftentimes, when you swing, you also miss.
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