Following on from a fortnight ago, I want to turn my attention to populating those sector allocations I presented with stocks. Of course, sector weights and stock selection should evolve over time but I will fix on “Ron’s portfolio” with a June 25-27 start date in this pedagogic series to maintain clarity. When the series ends, I can then quickly refresh the whole process referring back to these postings.
The number of stocks I choose depends more on spreading risk across the portfolio in case one or more turn out to be duds – and even blue chips on occasions become duds – than following a more general rule! I published a series of reports on this site and elsewhere on how many stocks one needs in a portfolio. After extensive statistical simulations at different points in time I conclude that round 8 – 15 is a useful guide in normal times and that might rise to 15 – 25 in volatile times, such as during the GFC. In all circumstances, one has to balance the difficulty of finding enough good stocks with the benefits to volatility.
When I construct a ‘real’ portfolio, I want to allow for not just ordinary volatility (measured by standard deviations) but a share price possibly imploding – almost to zero in rapid fire. Sadly it has happened to me so now I want to manage that risk even better! If I want 20 equally-weighted stocks, each gets 5% weight or $5,000 in a $100,000 portfolio. But when I introduce sector weights, clearer thinking is required. I have reproduced Table 1 with its sector weights from my previous column for convenience.