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FIRE Investing Retirement

How Much To Diversify?

As per a previous post, I only own 7 investments in my retirement portfolio.

Not exactly diversified, I guess.

I think the general consensus is you should own a broad spectrum of stocks or some kind of market or index fund to really maximize your diversification in the long run.

But, how many stocks do you really need?

HOW MANY STOCKS TO OWN?

I recently read this article that states you should own about 30 stocks to be diversified, but it also suggested that owning 12 to 18 stocks would give you 90% of the benefits of diversification.

For me, 30 stocks is a lot. I would have trouble tracking that many investments and would most likely loose interest. 12 to 18 is more reasonable, and as it turns out, you would still get some decent diversification.

WHY DIVERSIFY?

There are two types of risk – ‘market risk‘ and ‘firm-specific risk‘.

Market risk refers to the general movements or trends of the markets and you can’t do much about it expect be patient.

Firm-specific risk refers to ‘uncertainty of a specific area of the market or even a specific stock.’ – it is the inherent risk in one individual company because of the business it is in.

Diversification can help reduce firm-specific risk – by owning multiple different companies, the hope is that the ‘ups and downs’ of each company will offset each other over the long term.

Diversifying can also make up for a lack of knowledge in any specific business sector. You can buy multiple different sectors and hopefully, losses in one sector will be offset by gains in another.

But, I think if you end up owning more stocks that you need, you may as well just own a mutual fund or ETF, unless you enjoy researching lots of investments.

WHY I AM NOT ‘DIVERSIFIED’

At the age of 40, I made a startling realization – I was far behind in my retirement goals.

Throughout my 20’s I had made some financial mistakes and in my 30’s I took mini-retirements or sabbaticals (I’ll make a future post on this) and found that my retirement portfolio was not what it should be.

I realized that I did not have time on my side. It dawned on me that I would not be able to take advantage of diversification as I would had I been in my 20’s. My time horizon just wasn’t that long.

So, I made a decision to increase my risk profile substantially, and I decided to focus (mostly) on technology. I also own a banking ETF and a utility. That’s it.

Oh, and I also really like dividends.

I think it’s also important to enjoy what you do. I really enjoy reading about technology. I don’t think I could invest in something that did not interest me.

HOW HAVE I DONE?

It’s actually worked out quite well for me.

Sadly, I don’t own AMAZON, but I’ve done well on Applied Materials (AMAT) – it supplies equipment that makes semi-conductors plus it pays a dividend. I really enjoy reading about this company.

While I still cannot retire, it has turned into a decent nest egg.

Managing the portfolio is also not a chore since I have so few stocks and I enjoy researching them.

LACK OF KNOWLEDGE

Warren Buffet said, ‘diversification is protection against ignorance. It makes little sense if you know what you are doing.’

Do I know what I am doing?

At the start of my investing journey, I would say ‘probably not’ but now that I am older and wiser, I think I am better equipped than if I stayed with mutual or index funds.

The best hedge against ignorance is to educate yourself and just take action.

If you’re younger, I would say, just buy index funds … but if you’re older like me, and you’re willing to educate yourself, you may want to take a few extra risks.

As it turns out, you actually don’t need to have a mass of stocks in your portfolio.