It is becoming increasingly difficult to reduce the volatility of your stock portfolio.
That’s the conclusion of researchers who—at the top of the Internet-stock bubble nearly 22 years ago—calculated that a stock portfolio must own at least 50 stocks in order to ensure that its volatility does not match the market as a whole. is no more in comparison.
This was a much higher number than in previous decades, when at least 15 stocks would have done the trick. But a 50-stock portfolio would still have roughly the same level of volatility, as the volatility of the overall market had not changed much from the earlier decades at the turn of the century.
Today the picture is different, the latest study by researchers shows. Overall market volatility has increased over the past few decades – notably. Therefore, while 50 stocks is still enough to match the volatility of a portfolio to the overall market, investors will end up with a much higher level of volatility than was achieved with portfolio diversification prior to 2000.
Investment implications, says Martin Lettau, a professor at the University of California, Berkeley, and co-author of the latest study: Since you can’t foresee much of today’s market volatility, it’s something like “you just have to live with last week.” We got a taste of that greater volatility, with the Dow Jones Industrial Average rising 932 points on Wednesday and then falling an even higher-1,063 points on Thursday. If some investors are carrying such volatility too high, they may lose their exposure to equities. and invest more in asset classes such as bonds.
Other co-authors on the study are John Campbell of Harvard University, Burton Malkiel of Princeton University and Yexiao Xu of the University of Texas at Dallas.
the challenge of diversification
A good example of the low potential for diversification comes from the opposite stock’s behavior during three bear markets this century. During the bursting of the Internet bubble, a large proportion of the market’s overall volatility came from stock-specific factors rather than from the market as a whole. For example, when Internet stocks were falling, many other stocks were performing well. Average value stocks actually made money during the 2000-02 bear market.
The net result was that the overall market was no more volatile than it was in previous decades. It just took a large number of stocks to build a portfolio with volatility.
In contrast, during the 2008 financial crisis and the market downturn in the early weeks of the COVID-19 pandemic, share-price declines were almost universal. Overall market factors represented a large portion of the total volatility of stocks. As a result, even though a fully diversified portfolio still reduces volatility to market levels, the net result was still higher volatility than in previous decades.
still worth a try
Given the findings of this new research, is it less important to own many different individual stocks than in the Internet age? No, Prof. According to Lettau. Although overall market volatility has increased, “the level of stock-specific volatility, which can be diversified by holding multiple stocks, remains as important diversification as ever,” says Prof.
You could even argue that diversification has become more important than ever. As the overall stock market has become more volatile than in previous decades of US history, any additional volatility will be particularly difficult to stomach. “Underdiversified portfolios are not only exposed to high market volatility but also to avoid stock-specific volatility,” Prof. Letau says.
So, how many different stocks should an investor own? It depends on how much volatility an investor is willing to stomach, Prof. Letau says. But in general, the 50 stock remains a good target, he says. If investors don’t own that many individual stocks, they should invest in a mutual fund or exchange-traded fund that has at least as many.
This story has been published without modification to the text from a wire agency feed