Telecom Services 2. Utilities 3. Energy 4. Consumer Staples 5. Health Care 6. Materials 7. Information Technology 8. Financials 9. Consumer Discretionary Finally, you must be sure to own the next great overachievers. A study entitled The Capitalism Distribution, by Eric Crittenden and Cole Wilcox, of the Russell during illustrates just how difficult that is.
Below are some of the highlights of their study that present a visual representation of just how few of the individual stocks are actually going to be the winners you need to be picking. Figure 3: Total returns of individual stock vs. Russell You must ask yourself how realistic is it that you or your stock manager can identify the top performers before they perform?
What are the chances today that you have the undiscovered overachievers in your account? The global stock universe is huge. Ask yourself, how many stocks do you really need to capture any specific area such as the energy sector or the financial sector?
What if you only picked one and it was the one that went bankrupt? I doubt five per area would be enough, but for argument's sake, we'll say five stocks are adequate per area to feel confident. When you look at it like this, you need a minimum of five stocks in over industries, which equals over 1, stocks! Realistically I doubt even this number would be enough to capture the global equity portfolio. Some important things to consider before you start building a stock portfolio:.
You would still have your or your manager's biases embedded into the portfolio. Is your portfolio large enough to have a meaningful position size in each? So many stocks to trade would increase the trading cost. Administrative record-keeping and statements would be overwhelming. Very difficult, time-consuming, and expensive to research and manage.
Performance dependent on your proprietary system or "stock picking guruness. There are valid and rational concerns for not wanting to get into funds:. If somebody were to put 20 to 25 stocks in financial services only, for example, that is not diversification, Segram says.
They need to make sure those stocks cover at least seven to eight sectors. But picking individual stocks is a lot of work. Determining that means digging through their financials, checking up on their revenue and cash flow and analyzing their underlying fundamentals.
On top of diversification across different industries, investors also need to think about investing in companies of different sizes, and foreign companies as well as domestic. You also want to make sure not all the stocks in your portfolio have similar traits. For example, if you only have meme stocks in your portfolio, they may move as a group.
If you own specific stocks but don't cover all the bases of a well-diversified portfolio, you can fill in the gaps with funds. Say you have a portfolio with large-cap stocks, like Microsoft and Facebook. You can round out your holdings with a small cap index fund, an international index fund or alternative investments like real estate investment trusts REITs , says Leon LaBrecque, chief growth officer and financial advisor at Sequoia Financial Group.
The Bottom Line. Once you own a certain number of stocks, you have eliminated all the unsystematic risk. When you have reached this point, there is no need to own any more stocks to diversify your risk of concentration, that is, the unique risks associated with any one stock.
So how many stocks do you need to own to reach that point? Let's hear from the experts. Essentially, the theory says that if you are properly diversified, on average, you will get the same return in the market as if you had bought a passive market index.
Your email address will not be published. Save my name, email, and website in this browser for the next time I comment. Notify me of follow-up comments by email. Aidan Eccles Aidan Eccles is currently in his final semester at George Mason University and will be completing his bachelor's degree in finance. Kirk Cornwell says:. Jose Manstretta, CFA says:. Tomasso says:. Leave a Reply Cancel reply. Subscribe to Enterprising Investor and receive the weekly email newsletter.
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