We all know that over-diversifying our stock portfolios is bad for our wealth. Even if our main aim is simply to avoid the problems of correlated stocks all falling together it’s well known that you can get most of the benefits of diversification from a portfolio of no more than fifteen companies. Anything else isn’t diversification it’s diworsification: it adds no benefit and costs us more. Only, like so many well-known truths about stocks, this is a myth. Owning as few as fifteen stocks opens you up to all of the terrible things that happen to investors that take on too much risk. In the worst case everyone loses money and you get a socialist government. How bad is that?
Defined by Outliers Consider two portfolios each of fifteen stocks. Each stock holding costs us a thousand dollars. After ten years all fifteen stocks in the first portfolio have doubled and are now worth two thousand bucks each. In the second fourteen of the stocks haven’t changed their price at all but the fifteenth holding has multiplied sixteen times and is now worth sixteen thousand dollars. Both portfolios have precisely doubled in…
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