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| Course 501:
Constructing a Portfolio |
| Non-Market Risk and a Concentrated Portfolio |
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Interestingly, holding a concentrated portfolio is not as risky as one may think. Just holding two stocks instead of one eliminates 46% of your unsystematic risk. Using a twist on the 80/20 rule of thumb, holding only eight stocks will eliminate about 81% of your diversifiable risk.
What about range of returns? Joel Greenblatt in his book You Can Be a Stock Market Genius explains that during one period that he examined, the average return of the stock market was about 10% and statistically, the one-year range of returns for a market portfolio (holding scores of stocks) in this period was between negative 8% and positive 28% about two thirds of the time. That means that one third of the time, the returns fell outside this 36-point range.
Interestingly, Greenblatt noted that if your portfolio is limited to only five stocks, the expected return remains 10%, but your one-year range expands to between negative 11% and positive 31% about two thirds of the time. If there are eight stocks, the range is between negative 10% and positive 30%. In other words, it takes fewer stocks to diversify a portfolio than one might intuitively think.
Next:
Portfolio Weighting >>
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