Comments on: How Many Stocks Do You Need to Be Diversified?

By: Shane

Shane — Wed, 05 May 2010 15:40:53 +0000

One corollary to this argument that should be mentioned is that the statistical correlation is calculated based on historical data. The issue with that is the fundamentals of the market place change over time, the interconnectedness of industries can change as the world changes. A good example of this might be the latest US housing boom and bust (or the tech bust where the internet distorted the marketplace). Historically financials and real estate were probably less correlated than in the run up to this last bust (same with tech and everything else). That might lead one to believe that one is more diversified than one actually is. So, to be on the safe side you probably want to lean toward more rather than fewer. Given Buffet-like prescience 6 stocks may be enough, and 12 might be enough given normal circumstances, but considering how booms and busts seem to occur due to marketplace distortions, a little extra insurance is probably advisable.

By: Robert Wasilewski

Robert Wasilewski — Sun, 18 Apr 2010 11:08:41 +0000

In my opinion the beginning of the article needs to emphasize more that unsystemmatic risk also includes industry risk it’s not just a numbers thing. During the internet bubble people would say they were well diversified when in fact they were heavily overweighted in a single sector. More recently we saw the same thing happen for the finance sector.

By: Monevator

Monevator — Sat, 17 Apr 2010 12:50:42 +0000

Last time I looked, 12 stocks was near the optimal point for getting away from company-related risk. Obviously the more you add the more diversified you get, but it’s very much a case of diminishing returns.

By: Signals

Signals — Tue, 13 Apr 2010 02:41:35 +0000

The higher the number does not necessarily mean that it is better diversified. The key indeed lies in correlation. Picking the least correlated stocks would protect your basket from being swayed into one direction simply because an industry is doing well (or otherwise).

But as an individual investor, I still prefer to pick my own stocks and not to invest in index funds. But I guess, that’s just the gambler in me.

By: The Biz of Life

The Biz of Life — Sat, 10 Apr 2010 04:40:15 +0000

Statistically, they say 15 – 20 well-selected stocks in different lines of business. But why take the chance that you might pick a bunch of duds. Make it easy on yourself and just buy the whole damn market (VTI). You won’t make a fortune overnight, but over 30 years you’ll beat at least 75% of the pros.

By: Michael Harr @ Wealth...Uncomplicated

Michael Harr @ Wealth...Uncomplicated — Fri, 09 Apr 2010 21:45:50 +0000

This is a great article that does a terrific job of explaining diversification within asset classes. It also is a good application of statistical analysis where 30 is a sample size that does a relatively good job of approximating the larger population from which the sample was taken.

@Smarter Spend – I’m guessing that the 4 out of 10 and 7 numbers are relative numbers based on standard deviation measurements. Philip probably didn’t want to get into a discussion of sigmas with this post, but I’d say it’s a good relative scale with these numbers. The S&P 500 is usually just below the average of individual issues (stocks) and investors picking a stock touted on CNBC, in SmartMoney, etc. will frequently pick one that has above average risk…a 7.

By: Smarter Spend

Smarter Spend — Fri, 09 Apr 2010 20:20:25 +0000

If the risk level of the S&P 500 was a 4 out of 10 (with 10 being the most risky) then the risk associated with a particular company might be a 7.

Where are you getting these numbers?

By: Chris

Chris — Fri, 09 Apr 2010 20:08:12 +0000

Great article, and right on. Take home message? More risk for more reward… only after you have removed unsystematic (specific) risk.

By: Moneymonk

Moneymonk — Fri, 09 Apr 2010 18:23:20 +0000

I was going to guess 6

Warren Buffett once said that 6 single stocks is really all you need

By: Dan

Dan — Fri, 09 Apr 2010 15:31:35 +0000

(A different Dan)

Truth be told, there is market risk in every asset class, too. In the end, there is *some* correlation between ALL classes.

If it was truly possible to diversify away risk by holding multiple asset classes, we’d all be rich, because there would be a perfect mix.

By: Nickel

Nickel — Fri, 09 Apr 2010 14:59:27 +0000

Dave: While it’s possible to statistically reduce risk with a relatively small number of stocks, it’s not easy to identify them, and hardly worth the trouble. I would go a step further, and say to go with a Total Market fund instead of the S&P 500, or do S&P 500 *plus* a small cap index of some sort.

Dan: The premise of the article is not flawed. Philip says right there in the article that you can’t diversify away systematic risk without including multiple asset classes:

“The 30% that remains is the market risk, and without investing in other asset classes, you canâ€™t diversify away that market risk.”

By: Dan

Dan — Fri, 09 Apr 2010 14:12:25 +0000

If you want to be diversified you can’t just invest in stocks. Plain and simple. The premise of the article is flawed. You need to also go into bonds, real estate, cash. Maybe some gold, oil… baseball cards…

By: DAVE

DAVE — Fri, 09 Apr 2010 13:43:37 +0000

If you want to be diversified invest in an SP 500 INDEX fund.

Picking 5 or 10 individual stocks will not make you diversified.