Portfolio Diversification in Practice
The more holdings you add, the more risk falls, but from a certain point the benefit of additional diversification becomes negligible. How many is enough?
The Diminishing Returns of Diversification
The diversification benefit appears sharply at first, then gradually shows diminishing returns.
Estimates based on academic research: 1 holding: 100% individual-stock risk 5 holdings: only about 50% of market risk remains 20 holdings: about 85% of market risk is removed 50 holdings: over about 90% of market risk is removed 100+ holdings: additional benefit is negligible
With 20–30 holdings you can remove most of the individual-stock risk. Beyond that, the benefit is small relative to the management cost.
Instant Diversification with Index Funds
A single S&P 500 ETF diversifies across the top 500 U.S. companies. A global stock index (tracking MSCI ACWI) diversifies across more than 2,000 companies worldwide.
The diversification benefit of index funds is far more efficient in cost and management terms than buying individual holdings directly. Considering the time cost of researching and managing 20–30 individual holdings, it is realistic to get sufficient diversification with 1–3 index ETFs.
The Limit of Diversification: Market Risk Cannot Be Removed
No matter how much you diversify, there is a risk you cannot remove: market risk (systematic risk).
When the entire market falls, as in the 2008 financial crisis or the 2020 COVID crash, a diversified portfolio falls along with it. Individual-stock risk (unsystematic risk) can be eliminated through diversification, but a decline of the whole market cannot be avoided.
To reduce this market risk, you need diversification into assets beyond stocks (other asset classes such as bonds, gold, and commodities). Diversifying across holdings within the same asset class alone has limits.
With this service's portfolio simulator, you can compare the historical MDD of various asset combinations.
Preguntas frecuentes
Q. Do I get diversification if I buy Korean stocks and U.S. stocks together?
The correlation between the Korean and U.S. stock markets is around 0.5–0.7—they do not move completely together, but the correlation is high. In particular, they fell together during the global financial crisis. For full diversification, it is effective to also include asset classes beyond stocks (bonds, commodities, etc.).
Q. Is there a problem if a portfolio has too many holdings?
When investing in individual holdings directly, having too many makes management hard and becomes no different from replicating the index itself. Simply buying an index ETF is better. With ETFs and funds at the center, covering about 3–5 different asset classes is both sufficiently diversified and easy to manage.
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