How much should you diversify?
I have a
question regarding the stated results of highly
diversified investment newsletters. Are these
newsletters really practical for the average investor? I
mean, many of these newsletters recommend a large number
of stocks in order to match those results. "I would need to spend a
large part of my day monitoring such a portfolio!"
Hard-core investment letter types pooh-pooh this. With
modern software, they say, you can review 30 stocks or
more in just a few minutes. And there's a strong
argument that you should do this.
Years ago, the conventional
wisdom among finance academics was that you could fully
diversify against stock market risk with a portfolio of
only 15 to 20 stocks. As in so many other ways,
the conventional wisdom has been revised -- basically
because individual stocks have systematically become
more volatile. Now, research suggests the diversified
portfolio requires at least twice as many stocks.
Mark Hulbert's at
the Hulbert Financial Digest seems to indicate that
larger portfolios achieve
systematically higher returns than portfolios with 10 to
20 stocks. Of course, not
diversifying can result in spectacular success. The
top-performing letter of 2004, according to performance
data compiled by the Hulbert Financial Digest, was Fredhager.com, up 150.3 percent. But Hager achieved its
success in large measure with one stock: Rambus (RMBS) ,
a designer and licenser of intellectual property related
to memory chips. Yesterday, Rambus hit an air
pocket (not for the first time) when its fourth-quarter
showed unexpected declines because of the cost of the
litigation which is possibly its main claim to value.
The stock fell more than 16 percent Wednesday, closing
More about Fred.