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There's two parts to this answer. First, the numbers thrown around are that once you own 15 diversified stocks you have reduced your portfolio risk by 70 perce
by Lon7 9y ago
There's two parts to this answer.
First, the numbers thrown around are that once you own 15 diversified stocks you have reduced your portfolio risk by 70 percent. That's not bad. At this point your volatility may not be that different than a market index. Of course it's different for every set of stocks, but I think this is a safe-ish guideline. So in that sense you are not missing out a whole lot.
Second, and more importantly, it is very simple to put together 15 stocks with a low volatility, but also with very low returns. This is because the vast majority of the returns of an index come from a very small number of outperforming stocks. It's like the 90-10 rule. 90 percent of an index's performance comes from 10% of the stocks. Those aren't the exact numbers, but when you only pick 15 stocks, it is very likely that you will totally miss out on all outperforming stocks.
Here's an article that talks about this in more depth and uses real numbers: http://www.efficientfrontier.com/ef/900/15st.htm http://www.efficientfrontier.com/ef/900/15st.htm
- icelancer 9y ago>>This is because the vast majority of the returns of an index come from a very small number of outperforming stocks. This is the only thing the parent commenter needs to read to understand why indexing is not equivalent to owning 15 stocks that theoretically reduce portfolio risk (my guess is that the stocks are highly correlated and have too high of weight towards IT and not enough towards boring fields like industrials).
- rwmj 9y agoActually the opposite. Being in IT, I never buy IT stocks. They're mostly everyday brands and industries.
- icelancer 9y ago>>Being in IT, I never buy IT stocks. That, ah, is even worse. Your diversification... isn't. Just because you have a job in IT doesn't mean that's adequate exposure. There is a large difference between a paycheck and investments in the large cap IT sector.
- ng12 9y agoWhy not? I do the opposite -- I only invest in stocks in industries I know something about. It's the only appreciable alpha I have.
- misnamed 9y agoI wrote out a whole response (then deleted it) with that link in mind - perfect example with the other commenter's number (15). Didn't even know Bernstein's old site was still on anyone else's radar!