You may ask: In that case, how many types
of stocks should we hold for optimal, but not excessive, diversification?
I have no cut-and-dry answer.
When I first study how to pick stocks and
build a portfolio, I was told that the ability of diversification (i.e.
spreading the risk of a portfolio) reaches a peak when you hold 7 stocks. Any
further increase in the number does not help to reduce the risk because it is
likely that some of the stocks would have the risk overlap with each other. The
statistical jargon is there is internal correlation.
(Unfortunately, I cannot find the reference
or origin of this very number.)
How about me? At this moment, I owned 13
different stocks. In general, I try to keep it below 15 but at least 5. There
was a brief moment during the financial tsunami that I hold only 3 stocks (Hong
Kong China Gas, Link, and Yip’s Chemical). I don’t think this situation will
ever happen again.
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