Given that the law of diversification is about as close as one can find to a consensus belief amongst investors your portfolio is most likely to have at least a few stocks in it. But what if I was to tell you that the level and style of your diversification could be putting your capital significantly at risk?

The truth is that most investors don't know anything more about diversification than you "shouldn't put all your eggs in one basket". Spending some time trying to understand the ways you might be shooting yourself in the foot could seriously enhance your portfolio returns and stop catastrophic risk. But frankly who would want to trudge through all those finance journals?

Well, err… we did and here's what we've found…

1. You own too many stocks and the costs are crippling you

In 1977 Elton and Gruber published a landmark research note that showed that most of the gains to be had from diversification come from adding just the first few stocks. Adding 4 more stocks to a 1 stock portfolio gives you 71% of the benefits of diversification of owning the whole market. Even owning just 15 stocks brings about 87% of the benefits of a fully diversified portfolio.

Not only that but the more stocks an investor owns, the more likely they are to bleed away performance in higher transaction fees as the relative size of their orders are reduced in relation to the fixed costs of trading. These higher transaction costs significantly reduce long term returns especially in smaller portfolio sizes.

So if your stockbroker has you in a portfolio of 35 stocks in the name of diversification you can always quote Elton and Gruber while firing him for someone cheaper and (dare I say it) more exciting.

2. You own too few stocks and you are missing the winners

But hold your horses… William Bernstein, the renowned financial theorist, hit out at this '15 stock diversification myth' with a smartly argued case that while investors who only own a few stocks may have reduced their portfolio volatility the real risk they face is of significantly underperforming the market by missing the winners.

Bernstein showed that much of the overall market return comes down to a few 'super stocks' like Dell Computer in the 1990s which grew by 550 times. "If you didn’t have one of…

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