Many Irish investors buy individual shares rather than exchange-traded funds (ETFs) to avoid the penal tax treatment of funds. However, building a properly diversified portfolio may require far more stocks than one imagines.
The classic rule of thumb, dating back to 1980s research, held that a portfolio of about 30 to 40 stocks was enough to eliminate most company-specific risk. That number may be far too low, say the authors of Fomo in Equity Markets?, which analyses more than 87,000 stocks across four decades.
Even a portfolio of shares in 100 companies doesn’t eliminate the role of luck: an “unlucky” selection could lag a more fortunate one by several percentage points annually.
So how many stocks is enough? The researchers suggest true diversification may require hundreds – perhaps as many as 750 – to closely match the overall market.
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The reason is that market gains are dominated by a tiny few: just 2.1 per cent of companies created all net wealth, and only 30 companies – big winners such as Apple and Microsoft – generated a quarter. Most stocks, meanwhile, do little for investors, with 59 per cent failing to beat Treasury bills.
This leads to what the authors call “Fomo risk” – the fear of missing out. When returns are driven by a handful of outliers, smaller portfolios face a higher chance of simply never owning shares in the companies that generate the market’s biggest gains.
For fund-avoiding Irish investors, that creates an awkward trade-off: 30 or 40 shares may miss the market’s rare winners, but assembling a portfolio of several hundred stocks would surely test the stamina of even the most diligent amateur.
