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Deversification 20 stocks or 75 stocks
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I pulled this post from the Vanguard diehards board. See below. So, 2 questions: 1) Is this true? 2) So should we all be in index funds? http://socialize.morningstar.com/NewSocialize/asp/FullConv.asp?forumId=F100000015&convId=192863 is the link to the Vanguards post...
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http://kuznets.fas.harvard.edu/~campbell/papers/diversification.pdf
More generally, if you look at academic papers in the 60s, the recommendation was around 10 stocks. In the 70s it had moved to about 20 stocks. In the 80s it had moved to 30-40 stocks, and by the late 1990s academics were suggesting 75-100 or more. Basically, then, you have a rough doubling every decade (my thanks to a former professor for laying all this out).
As that paper briefly discusses, the basic drivers of this effect is that individual stocks are becoming more volatile and the risks they face are becoming more idiosyncratic. Again, I see this dynamic as a product of things like increasingly competitive markets, rapid capital responses to opportunities, risk-pooling, and so on.
As that paper also discusses, the good news is that the benefits of diversification (what is sometimes called the "only free lunch in investing") are increasing. The bad news for stock-pickers, however, is that to capture those benefits you need an ever-increasing number of stocks.
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Posted By Irina Clements on 01/26/2007 12:53 PM More generally, if you look at academic papers in the 60s, the recommendation was around 10 stocks. In the 70s it had moved to about 20 stocks. In the 80s it had moved to 30-40 stocks, and by the late 1990s academics were suggesting 75-100 or more. Basically, then, you have a rough doubling every decade (my thanks to a former professor for laying all this out).
The paper you cite refers to the risk of groups of "randomly selected stocks." I believe that if you select stocks with a goal of lowering the risk of investing in those stocks (say, by investing in stocks with low PE Ratios relative to their historical levels and that have a significant upside potential compared to the downside -- as in the approach used in Investor's Toolkit or Take Stock), that the lower overall risk in your portfolio means that you don't need the same level of diversification that you would need if you randomly chose stocks. I do recall seeing research just a few years ago that suggested that the number of stocks that were required in a well-chosen quality stock portfolio in order to provide the benefits of diversification had increased from 10-12 to somewhere on the order of 15-20. But what we do here at StockCentral is a far cry from what the Random Walk adherents do. Doug
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Deversification 20 stocks or 75 stocks
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