We often hear about the importance of portfolio diversification. This is essential for minimizing risks that arise when investing solely in specific assets or assets within a particular industry. However, some investors may become excessively focused on diversification. Here’s how you can maintain the necessary balance while shaping your portfolio.
It is important to note that no matter how diversified your portfolio is, risk can never be reduced to zero. Non-systematic investment risks can be minimized; however, no one is immune from systematic risks, as they can impact nearly all markets, and an increased level of diversification will not help in this regard.
According to modern portfolio theory, optimal diversification occurs when you add a twentieth asset.
Estimates from Edwin Elton and Martin Gruber suggest that the average risk of a portfolio with a single asset stands at 49.2%, while with twenty assets, the risk decreases to 22%. Notably, if you expand your portfolio from 20 to 1000 assets, the risk declines by only an additional 2.5%.
Many mistakenly believe that adding each new asset proportionally reduces risk; however, we observe that this is not the case, and lowering risks below a certain level is nearly impossible.
Certainly, this is not about simply buying any 20 assets—these must adhere to all principles of diversification.
