I am attaching a link to a recent Irish Times article on the size of an ideal stock portfolio.
Hi Sarenco
The wisdom of holding 10 stocks is considered in a Key Post elsewhere. The error in most of the discussion is that the researchers and commentators equate risk with volatility. This is primarily because they can measure volatility but they can't measure risk.
The only part of that article which would cause me to review the strategy is this:
"Bernstein’s says a handful of “superstocks” have historically accounted for the bulk of market returns."
"Separate research conducted by Longboard Asset Management found that, between 1983 and 2006, 39 per cent of stocks were unprofitable and almost two-thirds underperformed the market. Again, a minority of stocks accounted for all the market gains."
With 10 random blue-chip stocks, the risk that all would be loss makers is vanishingly small .39^10.
The risk that I would pick 10 stocks which all underperform the market is around 1.5% .66^10. They might well underperform the market but the portfolio could still be profitable.
The most likely outurn (based on the above figures) is that 4 of my stocks will be loss makers and 6 will make gains.
And, of course, I might be lucky in that I pick more than 6 profitable stocks.
I have not kept long-term historical records and maybe I will be able to reconstruct it from my files. My gut feeling is that the gains have far outweighed the losses. I have lost 80% on a couple of stocks e.g. AIB. But huge gains in other stocks e.g. Ryanair, Aryzta and DCC more than compensate for those losses. I need to check the records because it's quite possible that I have a selective memory, I might remember the gains and tend to forget the losses.
I also wonder if there is a timing issue here? During certain periods nearly all stocks go down together and in other periods nearly all stocks go up together. Most people invest over time and so that is a form of diversification in itself.
Actually, when I come to think of it, I did not lose 80% of my investment in AIB. I lost 80% from the peak to when I sold, but I built up my holding over many years and got a good dividend return during those years. So my actual loss was a lot less than 80%. Similarly my Aryzta shares are down 50% from their peak. But I bought them years ago when they were IAWS and so my gains on the share are still huge, although they feel like a loss maker to me now.
The other diversification which virtually all of these studies ignore is that most people have other assets e.g. their home and their pension. There is absolutely nothing wrong with a 35 year old who has €100k equity in their home and a secure job investing their €10k of free cash in one share. Of course, they probably should pay down their mortgage instead.
