Retail investors often find themselves stuck between two extremes. On one side, they spread their money across 50–60 stocks with tiny allocations, thinking more stocks mean more safety. On the other hand, they put most of their money into just 5–15 stocks they “believe in”. But both approaches have their downsides.
That brings us to the fundamental question: how much diversification is enough?
Let’s unpack the data and reasoning behind this magic number.
Diversification benefits flatten beyond 30 stocks
In the world of investing, the advice “don’t put all your eggs in one basket” is more than just a cliche; it’s backed by decades of financial research. At the core of this idea is Modern Portfolio Theory (MPT), introduced by Harry Markowitz in 1952. It explains how investors can construct an optimal portfolio that balances risk and return, primarily through diversification.
Diversification in a stock portfolio means different stocks, market caps or sectors to reduce risk. The logic is simple: if one investment underperforms, others in the portfolio can help offset losses. But like many things in investing, more is not always better.
Two kinds of risk that affect your stock portfolio:
- Systemic risk: Economy-wide factors, such as inflation, RBI interest rate changes, or global tensions like the Iran-Israel conflict, impact the entire market. No company, no matter how strong or well-managed it is, can escape these risks entirely, not even through diversification.
- Unsystematic risk: Risks like a company defaulting on its debt, a key managerial figure being caught in fraud, or sudden regulatory changes have a profound impact on that company’s stock. These are known as un-systemic risks; they are specific to a particular company or sector and do not entirely affect the broader market. For example, during COVID-19, many hospitality companies suffered due to lockdowns, while pharma companies thrived. Because these risks are company- or sector-specific, they can be reduced through diversification. If one company in your portfolio suffers, gains in other unrelated sectors can help offset that loss. That’s why spreading your investments is essential for managing un-systemic risk.
Modern Portfolio Theory shows that diversification initially reduces risk sharply. But after a certain point, adding more stocks stops making a big difference.
This graph clearly shows that most of this risk reduction occurs in the first 20 to 30 well-selected stocks. Beyond that, the curve flattens out, meaning adding more stocks doesn’t reduce overall risk by much. That’s why holding more than 30 stocks often adds complexity without offering meaningful benefits.
It’s not just about how many stocks you hold; it’s also about how much you allocate to each. The right approach is to ensure that no single stock takes up more than 5% of your portfolio. This way, each holding is meaningful, but no single mistake can do too much damage.
Sensex 30 vs Nifty 50: What India’s top indices reveal
India’s equity indices offer clear evidence that a well-diversified portfolio of 30 stocks is enough to capture the benefits of diversification without adding unnecessary complexity.
Despite having 20 more stocks, Nifty 50 hasn’t offered any significant advantage over Sensex 30, neither in terms of long-term returns nor in reducing volatility. In fact, the Sensex, with fewer stocks, has delivered slightly better returns and marginally lower risk.
Conclusion
This clearly shows that beyond a certain point, around 30 well-selected stocks, adding more doesn’t meaningfully improve the overall performance or lower risk.
Then why should your personal portfolio be any different?
Diversification is essential, but it needs to be done right. The evidence is clear that 30 well-chosen stocks strike the right balance between risk, return, and simplicity. Go beyond that, and you’re likely adding complexity without reward.
That’s precisely the idea behind Finology 30 – a basket of 30 high-quality stocks built only for long-term investors.
Finology is a SEBI-registered investment advisor firm with registration number: INA000012218.
Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before making any investment decisions.
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