Minimizing Your Portfolio Diversification
Posted by Blain Reinkensmeyer
July 3, 2007 at 12:56 am
Diversifying your investment portfolio is a very important factor to consider when stock trading online. Do you invest all your funds into one stock? Do you invest in 10 different stocks, or perhaps 20? The answer is less than 10, and it is solely dependent upon how much money you have to invest.
Diversification Breakdown
The easy way to look at it is like this:
- <$4,000 = 1 stock
- $4,000 - $10,000 = 1 - 3 stocks
- $10,000 - $20,000 =1 - 5 stocks
- $20,000 - $500,000 = up to 6 or 7 stocks
- >$500,000 = 10 - 15 depending
Concentrated Returns
The reason you should hold less stocks and not more is simply because of focused returns. One stock having a 10% day worth 20% of your portfolio is a heck of a lot better than a 10% move on a stock that only makes up 5% of your portfolio. If you follow your rules and minimize your losses you should be in good hands. Cut your losses to on average of 5 - 8% using stop loss orders and let your runners run.
Minimize Trade Commissions
Unless you are trading stocks for free, it is smart to keep your commissions to a bare minimum. There are many online stock brokers that can offer you good deals, heck some are advertised on this very page. Especially when you don’t have a lot of capital to trade with (say less than $10,000), trading smart versus often can save you big time. Back when I day traded I used rack up hundreds of dollars per month in commissions with only a $5,000 - $10,000Â portfolio, it was brutal.
Keep Things Simple
The last reason you want to only hold a few stocks versus many is to keep yourself focused and in the BEST possible stocks you can find. Unless you are in a raging bull market and are having monkeys pick your stocks because they are all going up you need to keep it to a minimum. I typically start with a few hundred, narrow them down to 10 - 20, then narrow down from there, leave for a few hours then check my final list again with a fresh mind for a 2nd opinion.
It Works
You may think this is dumb, why hold 7 stocks with a quarter million dollar portfolio? The answer is simple, because it works. I personally know the CEO of a multi billion dollar investment house, and their biggest fund they have clients in has an asset value of over $1 billion. The fund holds less than 40 stocks at any given time and has beaten the S & P 500 for years; now that’s proper diversification.
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I agree with you for the most part. If you have a day job, 6-7 stocks is plenty to try to keep track of. For me, investing is my life and I still don’t like to trade more than 25-35 names. The beauty of online trading houses these days is that one can trade for less than a penny a share even on small lots which puts the individual investor on a much more level playing field with the institutions. Heck, some people would even argue the individuals have the advantage now!
Time effectiveness definitely ties in there. I agree regarding the trade commissions being so minimal now a days, that is a huge help for sure. I’d argue institutions still have a huge advantage though over us simply based off the resources they have access to on a day to day basis
[...] While everyone talks about maximizing your portfolio diversification, Stock Trading 101 explains the advantages of Minimizing Your Portfolio Diversification. [...]
I totally agree. Ultimately, a diverse portfolio is more about a diverse asset allocation than diversifying within an asset class. If anything, you should want to get the best you can out of the stock asset class since it will likely be the one asset where you can generate the most return. This isn’t done by throwing a wet towel at the stock listings and buying as many stocks as you can, but by being smart and concentrating on finding the best performers.
So true, way too many over diversify and then they are statistically tied to the average… no wonder so many mutual funds can’t beat the average… statistically they are practically tied to it… and then they take off management fees…
[...] say doubles unexpectedly, you still aren’t making much headway in your overall portfolio. Minimizing your portfolio diversification works, and it is a matter of managing it with a stop loss and cutting your losses. Do you own 5 [...]