5 Factors that decide Diversified vs Concentrated portfolio

While some Investors believe that having a concentrated portfolio will give the best returns provided you know your stocks well, others believe diversification reduces your risk while sacrificing a little bit of returns.


Being an Investment Advisor, I have seen thousands of portfolios. Highly concentrated portfolios that are doing very badly, and highly diversified portfolios that are doing very good. Let us take some examples-

• A highly concentrated portfolio with 80% of value in just one small cap. Portfolio size of a few crores. What happened here-
• The company did well for initial 18 months but is down 60% over last 2 years. The business is not doing well
• Very illiquid stock– The investor is not able to get out of his position. Not much of a choice for him. Investor is stuck with one stock in the portfolio (was not able to exit at the right time and now can not exit for an unforeseeable period of time) – stuck forever?

• A diversified portfolio- 40 stocks. Portfolio value of 15-25 lakhs
• The investor has a regular job and is not able to track all the companies
• Each stock is worth a few thousands only, both gain and profit in one position is immaterial to the investor who has an annual salary of 25 lakhs
• The portfolio quality is below average and is under-performing Nifty
• Is it better to buy NiftyBees (Nifty ETF) than have a portfolio at all?

How many stocks  one should have in a portfolio? There are five factors to consider here-

1. Whats is the portfolio size?
• 2x annual expense or 30 times annual expense
• Bigger the portfolio, more difficult it will be able to replace the loss
• If someone earning 25 lakhs per annum loses 1 crore in a stock, what is the emotional and financial outcome?
2. Are you full time? How well do you know your stocks?
• No matter how well you may know your stocks, there are unique risks in each business. No one can know a Satyam or a Ricoh India in advance
3. Are you psychologically trained to withstand volatility?
• Portfolios with few stocks will have high volatility and periods of under-performance compared to the market
• Do you have the stomach?
4. What is your age?
• A 25 year old has atleast 30 years of earnings year ahead compared to only 10 years or so for 45 year old
• Do you have a long road ahead where one mistake can easily be fulfilled by others’ performance?
5. Asset Allocation
• Is all your money in stocks? Do you also have bonds to withstand volatility in the portfolio?

A 10-12 stock portfolio is a decently diversified portfolio for most categories of investors. The portfolio allocation of each stock should be a function of conviction, management quality, business quality, growth and valuations. However, if the portfolio size is too big, a 30-35 stock portfolio isn’t bad too provided you are able to track all your stocks and know them well





Happy Investing!
Source:Valueinvestor.com