Nevertheless, there remain fears of being too diversified or too concentrated, and the financial community is still divided about the “ideal” number of stocks to hold in a portfolio to achieve diversification and an optimal risk/reward balance. While we’d agree that investors shouldn’t put all their eggs in one basket, we also question whether the debate surrounding the ideal number of stocks is asking the wrong question entirely. More specifically, we posit that while portfolio diversification is key to investing success, the more pertinent factor driving this diversification isn’t the quantity of stocks, but rather, a portfolio manager’s conviction in the names they hold.
The law of diminishing marginal returns
Financial markets are unpredictable, and it’s common for investors and portfolio managers to believe that in their equity portfolios, a large number of holdings is crucial to reduce risk. But is this really the case?
1 For example, see Statman, Meir. “How Many Stocks Make a Diversified Portfolio?” The Journal of Financial and Quantitative Analysis, vol. 22, no. 3, 1987, pp. 353–363.