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Stocks · 11 / 13
Valuation and the investment decisionLevel 2Products9 minUpdated

Stocks in a diversified portfolio

Ten stocks from the same industry isn't a diversified portfolio. Diversification is measured by how differently your holdings react to the same news, not by how many lines the portfolio has.

What you'll learn
  • Why the number of holdings alone doesn't tell you about diversification
  • Where hidden concentration comes from
  • How many companies is enough in practice

The number of holdings isn't diversification

Chart · illustrative example
Eight lines, two exposures
The portfolio looks diversified, but most of it reacts to the same thing.
Industrial cycle

Engineering

Industrial cycle

Forest industry

Construction

Construction company

Construction

Building services

Construction

Equipment rental

Industrial cycle

Transport

Own driver

Healthcare

Own driver

Groceries

Six of the eight holdings move with the same economic cycle. When industry and construction slow down, they fall together. Only two lines bring real diversification. The measure of diversification isn't the number of holdings but how many different things the portfolio's return depends on.

Where does hidden concentration come from?

Industry
Several companies in the same industry react to the same demand, regulation and raw material prices.
Country and currency
Companies from one country are exposed to the same economy, interest rate level and currency.
Customer base
Companies in different industries may sell to the same customer group, for example to construction.
Home bias
Finland's share of the world stock market is small. Familiarity easily leads to overweighting.
Cyclical sensitivity
A heavy weighting in cyclical companies makes the whole portfolio sensitive to the economic cycle.
Your job
If you own shares in your employer, your salary and your investment depend on the same company.

A practical check: write one sentence for each of your holdings about what its return depends on. If the same words keep coming up, you've found the concentration.

How many companies?

There is no single right answer to this, and it makes no sense to give precise weighting recommendations. Two opposing constraints guide the choice.

Too concentrated
A single mistake decides the outcome.
In a portfolio of a few companies, one company's problem can wipe out years of returns. Concentration also increases the return potential.
Too spread out
You don't have time to follow your holdings.
If you have more companies than you have time to understand, the benefit of picking them disappears. A broad index ETF then does the same job with less work.

An honest question: how many companies' businesses can you be bothered to follow four times a year? That number is closer to the right one than any general rule.

Mini exercise
Test yourself: diversification
Pick an answer to see the explanation right away.
Kysymys 1 / 2
A portfolio has eight companies, six of which are export industry. Is the portfolio diversified?
Kysymys 2 / 2
What is a good starting point for the number of holdings?
Score: 0 / 2

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