How many shares do you need to spread the risk?

Some call it diversification. Others call it spreading the risk.

Many people think that you must have shares in many different funds and companies in order to spread your risk. I hear of people who own a LOT of funds (eg etfs) because they want to make sure they have as little risk in the market as possible.

Since a fund can easily have 500 companies (eg index funds that mirror the S&P 500) in it, they end up being co-owners of thousands of companies. Some even end up owning almost the entire market.

It’s downright silly.

But how many companies should you own to minimize your risk?

The truth is, it’s not as many as you think.

Here are some statistics.*

  • If you own shares in two companies rather than one, you minimize your risk by 46 per cent.
  • If you own shares in four companies, you minimize risk by 72 per cent.
  • If you own shares in 8 companies, you minimize risk by 81 per cent.
  • If you own shares in 16 companies, you minimize by 93 per cent.
  • If you own shares in 32 companies, it becomes 96 per cent.
  • …and with 500 companies it becomes 99 per cent.

Notice that it is far from a linear development. You get a big jump by going from one stock to four or eight.

But there is not much to gain from there. You gain only six percentage points by moving from 16 companies to 500 companies. After all, it makes no sense to own shares in thousands of companies.

If you land somewhere between 10 and 20 you have plenty of spread.

In fact, I would say that 10 is more manageable for you than 20, because if you are part owner of the companies, you also have to have the time and energy to keep up with the development, so that you can sell if something negative happens, such as their competitive advantage is broken.

“Diversification is risk minimization for idiots.”

Warren Buffett

His point is that you can’t just spread yourself over many companies and sit back.

There is also the risk that you get invested at the top of the market and that the entire market falls by 50-70 per cent.

Warren Buffett says that the best way to minimize your risk is to acquire knowledge about what you invest in.

How do you acquire knowledge?

Firstly, you need to stay informed about what is going on in society and the stock market.

Second, you need to research the companies in which you invest.

You must be able to answer some questions about the company before you buy shares in it. It can be good to have a checklist of questions that you need to answer. You can download my clear 1-page checklist here.

When you concentrate on a few companies, it is of course important that you have control over what you have invested your money in – and thus your future.

*Incidentally, these figures come from the first capital of the book You Can Be a Stock Market Genius by Joel Greenblatt.

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