But if 20 is the minimum, whats the maximum? A study conducted by Lawrence Fischer and James Lorie tracked the risk of investing in stocks against the number of stocks in a portfolio. The study found that risk drops dramatically as additional stocks are added to a portfolio, until it reaches the 20-stock level. After this, the inclusion of additional stocks reduces risk only slightly.
Once youve decided how many stocks you want to own, the next step is to address how you will allocated your investments among those stocks and among different industry groups. The precise answer will depend on your particular needs, objectives, time horizon and attitude toward risk, but here are some general rules:
- Consider spreading your portfolio among at least 12 industry groups.
- Invest no more than 10 percent of the portfolio in any one industry.
- Invest no more than 5 percent of the portfolio in any one stock.
The first two rules help lower sector risk the risk that the portfolio will be damaged by adverse developments in one industry sector. By spreading risk among at least 12 sectors, and by keeping exposure to any one sector to 10 percent or less, a collapse of one industry sector should not hurt the portfolio unduly.
The third rule is designed to reduce specific risk the risk that a development adverse to a particular company will hurt the portfolio. Keeping exposure to any one stock down to five percent or less will ensure that even if an individual stock tumbles 50 percent, it shouldnt decrease the overall portfolio value by more than 2.5 percent.