Wednesday, 26 September 2018

Non-Market Risk and a Concentrated Portfolio

Holding a concentrated portfolio is not as risky as one may think.

Just holding 2 stocks instead of 1, eliminates 46% of your unsystemic risk.

Holding only 8 stocks will eliminate about 81% of your diversifiable risk.


What about the range of returns?

Average return of the stock market during one period examined was about 10%.

Statistically, the one-year range of returns for a market portfolio (holding scores of stocks) in this period was between -8% and +28% about two-thirds of the time.  One-third of the time, the returns fell outside this 36-point range.

If your portfolio is limited to only 5 stocks, the expected return remains 10%, but your one-year range expands to between -11% and +31% about two-thirds of the time.

If there are 8 stocks, the range is between -10% and +30%.


Conclusion

It takes fewer stocks to diversify a portfolio than one might intuitively think.

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