Risk Diversification Benefits of Multiple–Stock Portfolios

Abstract

During the past seven years, not everyone with equity holdings may have profited from the extraordinary bull market. Private investors with large concentrated holdings in only one or a few stocks are vulnerable to significant risk of underperforming. The author of this article provides a useful framework for explaining the risk–return benefits of adding stocks to a portfolio. The analysis uses Monte Carlo techniques to simulate total returns of equity portfolios with varying numbers of holdings for the seven–year period ending December 31, 1999. The universe is based on the original constituents of the Russell 1000 as of December 31, 1992, adjusted for survivorship. The results suggest significant risk reduction benefits can be achieved by adding only a small number of stocks to a nondiversified portfolio.