Solving The Portfolio Puzzle by Tushar S. Chande
Stocks & Commodities Contributing Editor Tushar Chande presents guidelines for designing a stock portfolio.
Here's my question to all those superb stock traders out there: How many stocks should you have in your portfolio? One? Ten? A hundred? A thousand? Further, what are the tradeoffs? The tradeoffs you make greatly influence overall portfolio performance. Stock timing may be summarized as: What should you own and when should you own it? A corollary to the stock trading is the portfolio puzzle: What should you own and how much?
The answer differs. Professional mutual fund managers follow the hallowed principle of diversification, and academics concluded long ago that the variability of portfolio returns is reduced by adding more securities to the portfolio. However, they don't say much about what happens to the level of the returns as
you diversify. In addition, academicians want the different securities in the portfolio to be uncorrelated.
This is by no means a simple task. One effect of diversification is to reduce the individual security risk and to be left with market risk.
Market timing or stock picking in any form assumes the opposite: Take on individual security risk. Even though market risk can be substantial these days, essentially, diversification is the antidote to market timing.