Photo credit: Michael Dales

I tend to run a fairly concentrated portfolio at Sizemore Capital. My Dividend Growth portfolio – which is an income-focused long-only strategy – will generally have between 20 and 30 stocks at any given time.

There is no particular “science” that goes into this number. It isn’t a magic number, and I haven’t run studies to optimize it. But in my experience, 20-30 stocks is the sweet spot for me. It’s concentrated enough to allow for my favorite stocks to really have an impact on portfolio returns. But it’s diversified, so if a single stock has an unexpected blow-up on me, it won’t sink the portfolio.

I can also watch 20-30 stocks like a hawk. But that gets a lot harder at higher numbers. I couldn’t do in-depth research on a portfolio of 50 stocks, let alone 100. And frankly, once a portfolio gets that big, your best ideas get diluted to the point that you’re essentially a closet indexer.

I have no place for closet indexers. It’s not to say that I don’t see a place for index funds. I most certainly do. But a client doesn’t need to be paying active manager fees — which can be 1%-2% for long portfolios and the dreaded 2% of assets and 20% of profits charged by most hedge funds – for something that can be had at Vanguard for a fee of 0.09% per year.

When you let the number of positions in your portfolio expand, quality will inevitably start to suffer. If you have 100 “best” ideas, then they really aren’t your best ideas.

Of course, the downside to running a concentrated portfolio is that, when things don’t go your way, you can really underperform the market. Now, I could get into a much longer conversation about benchmarks, how they are misused, and why it’s a mistake to compare every portfolio to the S&P 500. But the fact is, if the market is up, even by a modest amount, and your portfolio loses money due to your concentrated investments not performing as expected, you’re going to have angry clients.