Why diversification in a stock portfolio? - kcchongnz
Author: Tan KW | Publish date: Tue, 10 Dec 22:05
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Why diversification in a stock portfolio?
The popular adage of "Don't put all your eggs in one basket" is very much suited for investing in the stock market. It advocates diversification, a technique that reduces risk by allocating investments in a number of stocks in the portfolio. Ideally the stocks chosen should be spread over different industries that would each react differently to the same event.
For example, the portfolio of 11 stocks here consists of companies of different industries; they are construction (Pintaras), Trading and Services (Kumpulan Fima, MFCB), Consumer (Haio, Homeritz), Industrial (Fibon, CBIP, Tien Wah), Technology (Willowglen, Datasonic), and Property (Daiman). Even within each industry, the stocks there are also lowly correlated. For example for the three stocks in the Industrial category, Fibon is in advanced polymer matrix fiber composites and electrical insulators, enclosures and meter boards; CBIP in palm oil equipment and retrofitting special purpose vehicles; and Tien Wah in printing works.
Stocks diversification won’t ensure gains or guarantee against losses but strives to smooth out unsystematic risks of companies in a portfolio which are not perfectly correlated so that the positive performance of some companies will neutralize the negative performance of others.
Kumpulan Fima, one of the eleven stocks in my portfolio here was my most favoured stock. It is still my favourite now. If I were to put all my money in this stock four months ago, I would only obtain a meagre return of just 1.32% as on 11 December 2013, way under-performed the broad market. With the diversification into the eleven stocks, my return now is 32%, out-performed the market with an alpha of closed to 30% in the last four months with some luck factors.
Modern Portfolio Theory by the Nobel Laureate Harry Markowitz has shown that when you have stocks that have low correlations together in a portfolio, you may be able to get more return while taking on the same level of risk, or the same returns with less risk. The less correlated the assets are in your portfolio, the more efficient the trade-off between risk and return.
Studies and mathematical models have shown that maintaining a well-diversified portfolio of about 20 stocks will yield the most cost-effective level of risk reduction as shown in the figure below.
This principle of stock diversification will continue to guide me in my stock selection in 2014.
The popular adage of "Don't put all your eggs in one basket" is very much suited for investing in the stock market. It advocates diversification, a technique that reduces risk by allocating investments in a number of stocks in the portfolio. Ideally the stocks chosen should be spread over different industries that would each react differently to the same event.
For example, the portfolio of 11 stocks here consists of companies of different industries; they are construction (Pintaras), Trading and Services (Kumpulan Fima, MFCB), Consumer (Haio, Homeritz), Industrial (Fibon, CBIP, Tien Wah), Technology (Willowglen, Datasonic), and Property (Daiman). Even within each industry, the stocks there are also lowly correlated. For example for the three stocks in the Industrial category, Fibon is in advanced polymer matrix fiber composites and electrical insulators, enclosures and meter boards; CBIP in palm oil equipment and retrofitting special purpose vehicles; and Tien Wah in printing works.
Stocks diversification won’t ensure gains or guarantee against losses but strives to smooth out unsystematic risks of companies in a portfolio which are not perfectly correlated so that the positive performance of some companies will neutralize the negative performance of others.
Kumpulan Fima, one of the eleven stocks in my portfolio here was my most favoured stock. It is still my favourite now. If I were to put all my money in this stock four months ago, I would only obtain a meagre return of just 1.32% as on 11 December 2013, way under-performed the broad market. With the diversification into the eleven stocks, my return now is 32%, out-performed the market with an alpha of closed to 30% in the last four months with some luck factors.
Modern Portfolio Theory by the Nobel Laureate Harry Markowitz has shown that when you have stocks that have low correlations together in a portfolio, you may be able to get more return while taking on the same level of risk, or the same returns with less risk. The less correlated the assets are in your portfolio, the more efficient the trade-off between risk and return.
Studies and mathematical models have shown that maintaining a well-diversified portfolio of about 20 stocks will yield the most cost-effective level of risk reduction as shown in the figure below.
This principle of stock diversification will continue to guide me in my stock selection in 2014.
Posted by kcchongnz at Dec 10, 2013 07:53 PM
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