Are there too many eggs in your investment basket?

Very often it is found that investors have a large number of securities in their investment basket. In the information age, with so many tools available, we get so many ideas that appear to be a good investment proposition. Acting on all of them leads to over-diversification of the basket. While diversification is good, over -diversification has many disadvantages and might prove to be counter-productive:

1 Over-diversification hampers one’s decision making ability with regard to deciding on appropriate entry and exit for a scrip. Since all of us have limited capacity of tracking the developments and understanding the dynamics of underlying business environment of a company / sector, a basket containing large number of instruments is extremely difficult to track. Mostly, we will be inefficient in managing such a basket.

2 Over diversification does not result into outperformance with respect to the respective correlated index. At best such a basket will perform in line with the index since the ratio of performing and non performing scrips will be nearly as distributed as the index constituents.

3 A large investments basket makes it difficult and time consuming to reconcile and track the corporate actions like dividends, bonus, rights etc.

So the question is how many instruments should our investment basket have?

If our decision making is perfect, if we are able to analyse the future developments to perfection and  if we know for certain the kind of companies that will perform well in future our holding should be confined to one and only one stock since we know that this one is stock will perform the best. Then there is no scope and need for any diversification of any kind

But we know that such an ideal (theoretical) scenario is an impossibility, we must have some kind of diversification to mitigate risk specially the non-systematic risk.

Depending upon the size of the investment basket in terms of value the number of holdings in it should be around 10 to 16. if the value of investment basket is very high this number could be higher but not more than 20 to 22 in any case.

If the total number of scrips is 15 the value of top 5 – 6 scrips should be 50% of the total and that of top 9-10 scripts should be 75%

When one will maintain such a discipline of keeping a cap on the number of scrips in the basket, the entry and exit decision for any candidate in the basket will be made after application of careful and nuanced considerations. This alone would improve the performance dramatically.

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