Hold 20 to 30 stocks to remove most company-specific risk. A diversified portfolio spreads money across holdings that react differently to events, so one failure does not decide your return. Unsystematic risk means losses tied to one company, not the whole market. Morningstar analysts concluded that 20 to 30 stocks remove the bulk of that risk on average.
Table of Contents
- What does early research show?
- Why do estimates range from 10 to 40?
- Is stock count alone enough?
- What should you do in practice?
What does early research show?
UBS Asset Management summarizes classic work by Evans and Archer. Most diversifiable risk disappeared after the 8th to 10th stock. Extra benefit was small beyond 10 to 15 equally weighted random stocks, according to the UBS summary of Evans and Archer.
Fisher and Lorie found a 32-stock portfolio was about 95% less volatile than holding a single stock. That result supports the 25 to 30 stock rule of thumb. Later work cited by State Street Global Advisors found 30 stocks still cut diversifiable risk by about 86%.
Why do estimates range from 10 to 40?
Meir Statman added trading costs to the math. He concluded a borrowing investor needs at least 30 stocks for a well-diversified random portfolio.
A lending investor needs at least 40 stocks. Morningstar analysts reached a practical middle ground in 2017. Owning 20 to 30 stocks will, on average, diversify away the bulk of unsystematic company-specific risk, as described in the Morningstar analysis republished by Bankrate.
Is stock count alone enough?
The SEC advises two levels of diversification. Spread money between asset categories such as stocks, bonds and cash. Then spread again within each category across individual holdings.
FINRA explains why correlation matters. Diversification reduces the risk of major losses from over-emphasizing one security or asset class. Protection is strongest when holdings are uncorrelated and react independently to economic events.
What should you do in practice?
Arizona State professor Hendrik Bessembinder found that just 4% of U.S. stocks created all net market wealth from 1926 to 2016.
In the same period, 57.4% lifetime-returned less than Treasury bills, according to the BBN Times summary of Bessembinder's research. Kiplinger data shows one broad index fund can exceed any stock-count rule. Vanguard Total Stock Market ETF holds over 4,000 stocks and Fidelity 500 holds about 500 companies.
- Check asset mix first, then count stocks inside the stock portion.
- Avoid clusters of holdings that rise and fall on the same event.
- Use one broad index fund if you cannot research and maintain 20 to 30 separate positions.