Can my stock investing be safe like an index fund? The advantage of index funds is that they are diversified, meaning that they hold a number of different stocks. This gives you diversification so that not all your eggs are in one basket. But, just how many eggs do you need to be diversified?
Research shows that with 20 to 30 stocks, you have all the diversification benefits you can get. You get the most diversification when you go from stock #1 to stock #2. You get less when you go from stock #10 to stock #11. Furthermore, if you buy large stocks, you already have some diversification, because those companies are involved in many businesses in different markets.
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So, you now know that you would rather own your own buy-and-hold stock portfolio rather than invest in an index fund. You need not worry if this approach is as safe as investing in an index fund. Since safety comes from diversification, the more stocks you own and hold, the less risk there is because each stock is only a fraction of
your overall portfolio.
How do you then build diversification in your own portfolio? There are two ways. The first way is to invest in large companies because large companies are already diversified through the many businesses in which they are involved. Secondly, research shows that you only need 20 to 30 stocks to gain all the diversification benefits as you would derive from an investment in an index fund. These benefits can start just from owing two stocks instead of one and continue each time you add an additional stock to your growing portfolio. By the time you have acquired 20 to 30 different stocks you have gained all diversification benefits and safety as you would have received from an investment in an index fund.
So remember: safety comes from diversification and all you need to do is to invest in 20 to 30 large stocks to get the benefit.
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