How Many Stocks Should I Own? The Science of Diversification

How to Choose the Number of Stocks for Your Portfolio: Academic Research Shows the Way

According to academic research, you should own at least 10 stocks in your portfolio to achieve a 90% diversification, and if you own 20 to 30 stocks, your portfolio will perform better than average.

How many stocks should you own in your portfolio? This article answers that question by discussing portfolio management and how diversification research can help you choose the number of stocks to own in your portfolio.

We will also offer recommendations on the number of stocks we believe are ideal for most investors. We start by briefly discussing portfolio management and diversification.

How Many Stocks Should I Own? The Science of Diversification
How Many Stocks Should I Own? The Science of Diversification

What is portfolio management?

Portfolio management is the process of selecting and managing a group of investments that are held in a portfolio. The goal of portfolio management is to maximize returns while minimizing risk. Many different investment strategies can be used when constructing a portfolio, but diversification is one of the most important factors to consider.

What is diversification?

Diversification is the process of spreading your investment capital across a variety of different asset classes and securities. Diversification helps minimize risk by ensuring that your portfolio is not overly exposed to any particular security or asset class. When it comes to stocks, diversification can be achieved by investing in a variety of different companies that operate in different sectors and industries.

Markowitz’s Research & Modern Portfolio Theory

Extensive research has been conducted on the topic of diversification and portfolio management. Harry Markowitz conducted one of the most famous studies on this topic in 1952. Markowitz’s study showed that diversification could help reduce risk while providing the potential for high returns. Markowitz is the father of modern portfolio theory (MPT).

Surz & Price’s Academic Research on Portfolio Diversification

Surz and Price recommend a minimum of 20 stocks in a portfolio, according to their research in 2000.

In their academic paper “The Truth About Diversification by the Numbers,” Ronald J. Surz and Mitchell Price discuss the research on portfolio diversification and recommend the number of stocks to own in a portfolio.

They begin by noting that there is no perfect number of stocks to own, as this will vary depending on an individual’s risk tolerance and investment goals. However, they provide a general rule of thumb based on modern portfolio theory (MPT) that suggests owning between 20 and 30 stocks to achieve adequate diversification.

Surz and Price explain that MPT is a theory that suggests that it is possible to improve the risk-return profile of an investment portfolio by including a variety of different assets. This is done by spreading the risk across different asset classes, which helps minimize the impact of any security or market segment on the overall portfolio. Surz and Price recommend owning between 20 and 30 stocks to achieve adequate diversification.

Source: The Truth About Diversification by the Numbers”, Ronald J. Surz and Mitchell Price (2000)

Research on Number of Stocks Needed in a Portfolio

Vitali Alexeev & Francis Tapon recommend at least 30 stocks in a portfolio in the 2012 research paper, “Equity portfolio diversification: how many stocks are enough?”

The article looks at the number of stocks needed in a portfolio to achieve optimal diversification. They studied five developed markets and found that the number of stocks necessary to achieve diversification varies from market to market. They recommend a minimum of 30 stocks in a portfolio to achieve diversification.

The study found that the number of stocks necessary to achieve diversification decreases as the market capitalization of the stocks in the portfolio increases. They also found that portfolios with a higher number of stocks tend to have lower volatility and higher returns.

Source: Equity portfolio diversification: how many stocks are enough? Evidence from five developed markets. Vitali Alexeeva,& , Francis Tapon

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Alexeev & Dungey’s Research on Diversification

In the 2014 paper “Equity portfolio diversification with high-frequency data,” Alexeev and Dungey suggest that 10 equally weighted stocks in a portfolio can achieve 90% diversification.

“We find that for investors wishing to diversify away 85% (90%) of the risk, equally-weighted portfolios of 7 (10) stocks will suffice.”
They explore how factors such as company size, industry, and country play into the benefits of diversification.

The study found that while industry and country-level diversification are important, company size is not a significant factor in reducing risk. This suggests that investors would be better served by allocating their capital across a larger number of companies rather than focusing on industries or countries.

This research is important for investors looking to minimize their risk without sacrificing too much potential return. Following the study’s advice, investors can create a more diversified portfolio that is less likely to experience sharp declines in value during tough economic times.

Source: Equity portfolio diversification with high-frequency data” by Vitali Alexeev and Mardi Dungey (2014)

How Many Stocks Should You Own?

Based on the academic research, you should own at least 10 stocks, and investors with larger portfolios should try to own at least 20 to 30 different stocks. This will help to ensure that your portfolio is properly diversified and that you are not taking on too much risk.

Of course, you will need to adjust this number based on your specific circumstances and investment goals. Ultimately, it is up to you to decide how many stocks you should own in your portfolio.

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