How Many Stocks Do You Need to Be Diversified?
Among those who invest in individual stocks, one of the most commonly misunderstood concepts is that assured diversification can be accomplished with a relatively small portfolio of common stocks. Many people believe that diversification beyond 10 or 20 securities is superfluous despite clear research indicating that the opposite is in fact the case. Even some investment textbooks have helped spread the confusion.
The major reason for the confusion rests with the interpretation of many of the studies that have examined the relationship between the risk of a portfolio and the number of securities that it holds.
In this article, we clarify the previous findings by taking a fresh look at this relationship.
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Donald R. Chambers is the Walter E. Hanson/KPMG Peat Marwick Professor of Finance at Lafayette College in Easton, Pennsylvania.
John S. Zdanowicz is professor and director of the Center for Banking and Financial Institutions, Florida International University, Miami.