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ETFs provide diversification in rocky markets. (iStockphoto)
ETFs provide diversification in rocky markets. (iStockphoto)

How many stocks do I need for proper diversification? Add to ...

One reader recently asked: How many stocks do I need for proper diversification?

The Answer:

There isn’t a clear-cut answer to this question. The late value investor Benjamin Graham argued that a portfolio of 10 to 30 carefully-chosen stocks provides all the diversification you need. Other studies have concluded that, if you’re picking stocks at random (which you should obviously never do) you’d need 50, 100 or more in order to have volatility similar to the market as a whole.

“The academics disagree over how many separate stocks are required to secure the benefits of diversification, but most professionally managed equity portfolios have at least 30 or so individual securities in them,” U.S. fund manager Daniel Peris wrote in his 2011 book, The Strategic Dividend Investor.

If you’re a do-it-yourself investor, you have to balance the need for diversification with the ability to monitor your holdings. For most people -- except perhaps those who can devote several hours a week or more  to investing -- staying on top of corporate developments for 30 or more stocks is going to be a challenge.

It’s also important to remember that owning a large number of stocks won’t, by itself, guarantee diversification. A portfolio of 30 banks, for example, doesn’t provide adequate diversification. You should aim to own companies in a variety of sectors.

In my own portfolio, I own about two dozen companies -- including banks, utilities, pipelines, power producers, consumer products makers, insurers and real estate investment trusts -- plus a handful of low-cost exchange-traded funds and mutual funds that provide exposure to other sectors as well.

The easiest way to achieve excellent diversification -- and dramatically cut down on the work required to monitor your holdings -- is to devote most or all of your portfolio to low-cost index funds. If you don’t have the time or expertise to monitor individual stocks, this is a great way to go.

--John Heinzl

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Follow on Twitter: @johnheinzl

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