European stock markets have raced ahead this year, helped in part by monetary stimulus and a view that Continental shares looked good value at the turn of 2015. To an extent it seems that investors were prepared to bet that the European economy was finally on the mend. As a result, the FTSE Eurofirst 300 climbed by more than 20% in the first four months of the year.

Yet for the past six years, any investment in Europe has come with the nagging caveat that Greece could cause havoc in the market by going bust, defaulting on its debts and quitting the Euro. In recent days that’s started to look increasingly likely - and markets are pulling back in response. While the outcome for Greece - and stock markets generally - is unclear, these periods of uncertainty are a reminder about how crucial it is to keep on top of portfolio housekeeping. There could be volatility ahead… it’s time to buckle up.

Diversification - the risks of too few stocks

Walter Schloss, the late American bargain share investor who trained under Benjamin Graham, used to diversify his deep-value strategy by holding as many as 100 different shares. In reality, this level of diversification is too costly and far too cumbersome for most investors. Yet the risks of owning too few stocks - or stocks that are too closely correlated - can be considerable.

An examination of 60,000 individual accounts at a US retail brokerage between 1991 and 1996 found that investors were generally under-diversified. The average portfolio consisted of between four and seven holdings. But even those with more stocks weren’t necessarily better diversified. The researchers found that more holdings often meant greater correlation because investors simply picked companies in the same sectors. From the perspective of returns, they found that the least diversified 10% of investors earned 2.40% less annually than the best diversified 10% in the group on a risk-adjusted basis.

But how many stocks is enough? Another study - this time by American professors Gary Newbould and Percy Poon - found that the oft-recommended portfolio size of eight to 20 stocks actually produced a very volatile performance. So they suggested thinking about things another way. Rather than select a specific number of stocks, investors should select a probability of success they are comfortable with and then figure out how many stocks are required…

Unlock the rest of this article with a 14 day trial

Already have an account?
Login here