Why is it better to own lots of diversified stocks over a specific set of target stocks?

March 12th, 2008 | by admin |
KnottedBrain asked:


Alot of people say that you should have a diversified portfolio. Why can’t I just choose the stocks which I feel have potential for growth? That might narrow my choices to a few sectors, though. If I buy too many stocks, my gains will be lost by too much other stuff going on.

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  1. 2 Responses to “Why is it better to own lots of diversified stocks over a specific set of target stocks?”

  2. By muncie birder on Mar 14, 2008 | Reply

    It is not necessarily better. The idea behind owning a portfolio of diversified stocks is geared toward the long term investor who will be happy to sit on his positions for an extended interval. That does not necessarily mean lots, but it does mean at least 20 different stocks in varying sectors. A diversified holdings tends to mitigate the risk of a particular sector suddenly having a debilitating effect on your well being ie banks, home builders, mortgage lenders. Get the idea? You can certainly choose to avoid certain sectors and over weight other certain sectors. Don’t you just love that term over weight? But if your over weighting is based on a false premise, you can wind up regretting the over weighting overly much. There is even a term for it–specific risk–as opposed to systemic risk, a fancy name for market risk, which is the risk equity investments are currently suffering–bear market.

  3. By Rob A on Mar 16, 2008 | Reply

    To make it simple:

    If you have a diversified portfolio, a change in one of the company’s status will have less of an impact on your total investment. If you had 20 stocks with Enron being one, then the effect of Enron’s stock losing its entire value would have less of a drag on you than someone with the same dollar amount of stocks, but holding Enron and two other companies.

    The effect of Enron on you was 1/20 or 5%, while the other investor would have 1/3 or 33% loss.

    Diversification just reduces the risk of your stock holdings.

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