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Diversified Portfolio with lower Expenses
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As part of my duties at ICLUBcentral I do data analysis to find entry errors for customers. Sometimes I see other possible problems. One of the other problems I saw several times recently is too many stocks in a portfolio. These portfolios had approximately the same value as my club. However, they had 4-5 times as many stocks in their portfolio. One portfolio had nearly 100 companies.
Having a diversified portfolio helps decrease risk as different companies in different economic sectors perform differently during the business cycle. Much research shows risk decreases rapidly as more companies are added to a portfolio. Risk reduction then slows and a portfolio of 15-20 stocks captures nearly all the risk reduction of a diversified stock portfolio. This does assume the stocks owned are spread among multiple sectors of the economy.
Owning more than 20 companies in your portfolio does not significantly reduce your risk. It does add to your expenses. The more companies added, the more trading costs play a role in total returns. Also, as more companies are added to a portfolio the less each can contribute to the total return. A 100% gain for a company that is 1% of a portfolio can only add 1% to the total value. Finally, as the number of stocks owned increases it becomes harder to track and monitor the companies in the portfolio. When to sell is often the hardest part of portfolio management. Increased numbers of companies in the portfolio increase the chances of missed sell signals.
As I became a more experienced investor a piece of advice I thought good was "Picking quality companies at a reasonable price is especially important when starting a portfolio. As the portfolio grows then portfolio management becomes more and more important." So don't forget to hone your portfolio management skills. StockCentral and ICLUBcentral have tools to help but that will wait for a different post.
Russell Malley
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Diversified Portfolio with lower Expenses
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