How many stocks does it take?

That great investment guru Benjamin Graham in his book “The intelligent investor” advised adequate diversification but warned about too much diversification. The debate about how many stocks in your portfolio you need to own to maximize returns but minimize risk is still out there. The modern portfolio theory (MPT) was proposed by Markowitz in the early 1950’s and Nobel Prizes have been awarded in this area of economics. Jason Zweig had a good review in a recent WSJ column. He recounted an interesting study led by Professor Chance where he instructed over 200 students to invest one stock followed by others until they had invested in 30 stocks. For the entire group, the risk went down 40% by going from 1 to 20 stocks. But, when they increased their holdings to 30 stocks, their risk increased. Mr. Zweig pointed to a study by the Federal Reserve, which showed that 84% of households that owned direct shares owned no more than 9 stocks and a surprising 36% only owned a single stock. Most ‘experts’ including Graham and Malkiel advise that owning between 10-30 stocks assures you about 90% of the benefit of diversification. If you own this magic number of stocks you eliminate what is called ‘unsystemic’ risk. (See Chapter 2 of Volume 3 of The Smarter Physician
I guess the question is: If you do not know how many stocks and what kind to own, aren’t you better off owning a mutual fund? Of course, most mutual funds include many (often hundreds) stocks. Then, most of us want to diversify further by buying funds of various kinds, not realizing that a lot of funds own the same stocks! This ‘asset correlation’ if zero reduces portfolio risk because the funds move independently of each other. I know of no one that actually checks and compares each fund to see if they own duplicate stocks. Even, if you decide to buy ‘value’ versus ‘growth’ or ‘small’ versus ‘large’ caps or even ‘financials’ versus ‘healthcare’ sectors , do not be surprised to see some overlap in this day of mega conglomerates. You could own something like the U.S Total Stock Portfolio, an index fund that captures tons of companies.