Learn the stock market › Risk › Lesson 4 of 5

How many stocks do you need to diversify?

Short answerThere is no exact number, but each company you add makes the result depend less on which ones you happened to pick, most of all at the start. Among 19 of the largest US companies, a single company returned between +11.6% and +59.5% a year over the last ten years. Ten companies picked at random returned between +18.6% and +39.9%. Diversifying lowers the risk of one company, not the risk of the whole market falling.

Random baskets

Here the same amount of money has gone into randomly picked companies among the 19 largest US companies today that have prices since Nov 6, 2016, bought once and never changed. The table shows the worst, the middle and the best basket of each size:

Companies in the basket	Worst	Middle	Best
1 of 19	+11.6%	+20.8%	+59.5%
5 of 19	+15.4%	+30.3%	+46.7%
10 of 19	+18.6%	+33.2%	+39.9%

Return per year from Nov 6, 2016, the same amount in each company, bought once. 2,000 random baskets per size; one company is each of the 19.

The gap between the worst and the best basket shrinks quickly from one to five and ten companies. With all 19 there is only one basket, and nothing is left to be lucky or unlucky with. Why a single company usually returned less than all of them together is explained in the lesson on the difference between stocks and funds.

None of the companies lost money over the ten years. That comes from the selection: they are the largest today, and so among those that did well. How deep even they fell on the way is in the lesson on how much you can lose.

What diversification does not remove

The companies in a basket trade on the same market and often fall together when the whole market falls. Spreading protects against one company doing badly, not against a crash. How far the whole market has fallen is in the study of market crashes. A fund spreads money the same way, see the lesson on mutual funds.

Test yourself

You own five companies and add five more, picked at random. What usually happens?