Optimal Portfolio Diversification

Seamless texture with spices and herbs

Today, I welcome another new reader who has signed up to follow my blog. Thank you very much. I have two new subscribers in two days. Wow!

Just this alone is sufficient to motivate me to do another blog post 🙂

In one of my blog posts, a fellow blogger commented “I personally only have 1 portfolio as you might know and I’ve not bought a new stock for 2 months now. I can’t imagine having to handle 3 at the same time, when 1 is already very time consuming! Something that you might want to consider is if you are too diversified, and also reflect on your original investment goals again which you have done in your previous post.

I wasn’t able to respond to her promptly then as I was just too overwhelmed by too many things going on. I finally got a bit of breathing space now and I feel I owed her a proper reply.

She is right!

I appreciate greatly her concern and took the effort to pen me her views.

If you do a simple google search for the optimal number of stocks to hold in a portfolio to achieve ideal diversification, it is quite often that you will find that most people and researchers will say it is between 20-30 stocks (same as what’s my business lecturer said many years ago). Any more than that, we would not be able to handle the demands of researching and understanding their businesses thoroughly before investing and the downsides of diversification starts to outweigh the benefits.

You can read more about the concerns of over diversification in this website: https://www.investopedia.com/articles/01/051601.asp

This is the famous chart in most financial textbook (see its the magical number 20 … it brings back memories of my student days … LOL)

div

Followers of Warren Buffett will be able to quote this Great Man saying “Wide diversification is only required when investors do not understand what they are doing“. In other words, if you diversify too much, you might not lose much, but you won’t gain much either.

Like a corporation that goes into many different unrelated businesses, if we over diversify we are unlikely to get value because precious time, energy and resources are diverted from the original investment objectives. There is even a term for this: “diworsification” which was coined by the legendary fund manager Peter Lynch in his book One Up On Wall Street.

Her timely comments prompted me to reflect on my active stock portfolio. Yes, I have an passive index portfolio too which my regular readers would be familiar with.

Let me start with the big picture and then slowly narrow down …

Currently, my watchlist has 101 local STI stocks, 22 HK stocks and 26 US stocks. Kinda of think of it … its overwhelming enough …

Do I look into all of them? Not really but I have to admit that I still spend some time tracking them somehow. For example, I track their dividend distribution during the quarterly result release … click to see this quarterly dividend distribution by the stocks in my watchlist.

Honestly, it is quite tiring.

survived

In my active portfolio, I did a count and realise that I actually own 57 stocks – almost double the researched optimal number … OMG!!!

So, as all good engineers will do, I started to plot the pareto chart of the stocks in my portfolio against their weightage of their value in my portfolio.

Interestingly enough, the 80-20 rule starts to emerge.

My top 20 stocks (by valuation) make up 74% of the value of my portfolio. This increases to 86% if I count the top 30 stocks. Maybe things aren’t that bad if I just pay attention to the top 20-30 stocks and forget about the rest.

By the way, below is the pareto chart:

Pareto

Sorry I know its too small to read … probably another reason why I should trim it …hahaha

Well, I will not be trimming down the number of stocks in my portfolio deliberately … actually some of them are so “devastated” that I probably won’t look at them anymore … like Noble, First Ship Lease Trust … even mentioning them brings me sorrow. 🙁 By the way,to digress a bit, I have a young engineer in my office who was shocked to learn that I actually lost money in the stock market … yes, young man, if you are reading this, yes no matter how experienced or an expert you are in stock investment, you will still lose money from time to time as no one has the prefect crystal ball. And there is something called the black swan event

Admittedly, I am probably on the over-diversified side and the extra number of stocks will not bring real benefits to me. To trim it now is difficult, what I should do now to at least resist adding more for a start.

Ah … since we are on this topic, some of you may be interested to know what are my top 10 stocks. I realised that I haven’t blogged about it for a while already … so, let me just do a simple update here:

They are:

  1. Singtel
  2. SPH
  3. Cache
  4. ComfortDelgro
  5. Starhill Global
  6. SIA Engineering
  7. M1
  8. IREIT
  9. OUE Com Reit
  10. Sheng Siong

I can already hear some of you saying “why you buy this”, “SPH??? Sure or not?” etc …. (sign) some of them are genuine value stocks that I want to keep (like Singtel) while some are sadly legacy issues that I lacked the resolve to cut loss then and hence, now I have to carry them and it take a while to unwind them (like SPH) ….

But All of them are dividend stocks and I am definitely looking forward to the time whenever they declare dividends … looking forward to Q1 2018 when a new stream of dividends will come in again.

Till then, take care folks and I hope you find something useful in this blog post.

Warriortan

collectdividend

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One thought on “Optimal Portfolio Diversification

  1. Interesting analysis. My approach has been to perform enough research to be comfortable with the decision, determine where to position it (similar to your three buckets) and monitor the news feed for company/country/industry impacts. Most important is to understand the rationale behind your decision to purchase. Of slightly over 200 stocks in 20 countries, 36 account for about 70% of my dividends. Although rare, I’m not averse to selling when conditions change.

    Good luck on finding YOUR right number 🙂

    Like

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