“Don’t put all your eggs in one basket.”
It is probably one of the first lessons most investors hear. Diversification is often presented as the safest answer to investment risk: own more funds, more stocks, more sectors, and the portfolio becomes safer.
But there is a point at which diversification stops reducing risk and starts diluting the very returns you are investing for.
This raises a rather uncomfortable question: How diversified is too diversified?
More stocks do not automatically mean less risk
A portfolio of 200 stocks may look safer than one holding 20. But the real question is: what kind of risk are we diversifying against?
If the concern is that one company may permanently destroy capital, owning several companies can certainly help. But diversification does not automatically protect against buying expensive businesses, weak businesses or businesses that do not fit the investment thesis.
In fact, excessive diversification can create another kind of risk: dilution.
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If a portfolio owns 200 companies and 150 of them have less than 1% allocation, even a strong performance from one of those companies may have very little impact on the overall portfolio. Meanwhile, several weaker holdings can collectively drag performance down.
This is especially relevant when a portfolio becomes large. A fund managing substantial assets cannot necessarily deploy all that money into a small number of stocks, particularly in less liquid segments of the market. The size of the fund itself can therefore push the portfolio towards greater diversification.
So the number of stocks alone tells us very little.
The more important question is whether every holding has a meaningful reason to be there.
But concentration has a risk of its own
This is where the argument becomes more interesting.
A concentrated portfolio can create meaningful upside when the underlying investments are right. But concentration also magnifies the consequences of being early, wrong or simply too optimistic.
Imagine putting 15% of a portfolio into a company that takes three years longer than expected to deliver on its potential. The problem is not necessarily that the company is bad. The problem is that the portfolio may not have enough room to wait.
For a professional portfolio manager, this becomes even more important because the investor’s experience matters. A strategy that can theoretically withstand a 40–50% drawdown may still be unsuitable if the investor is likely to exit when the portfolio falls 10–15%.
This is why concentration cannot be judged independently of investor behaviour.
A portfolio is not managed in isolation. It is managed for someone.
The real risk may be elsewhere
Perhaps the most useful way to think about concentration is to stop asking, “Is concentration risky?”
The better question is: “Where am I concentrating?”
Concentration in an attractively valued, financially sound business after a significant correction is very different from concentration in an expensive sector at the peak of market optimism.
The same sector can represent very different levels of risk at different points in the cycle.
That is why concentration should not be static. As valuations, earnings expectations and market conditions change, the appropriate level of exposure can change too.
A sensible process may therefore involve starting with an underweight position, moving towards market weight and only gradually becoming overweight as conviction strengthens. Building a position responsibly can matter just as much as the eventual position size.
The objective is not to be concentrated at all times. It is to concentrate when the odds justify it and reduce concentration when the risk-reward becomes less favourable.
Diversification should have a purpose
This also changes how we should look at mutual fund portfolios.
An investor may own five or six funds and believe the portfolio is diversified. But if those funds all own similar companies, sectors or investment styles, the apparent diversification may be much greater than the actual diversification.
On the other hand, a portfolio containing a few carefully selected funds can be sufficiently diversified if each fund serves a distinct role.
The same principle applies to individual stocks.
There is no universal number of stocks that makes a portfolio “safe”. The right number depends on the quality of the businesses, their valuations, correlation between holdings, liquidity, investor temperament and investment horizon.
Even investment strategy itself can become a source of concentration. A portfolio may be diversified across 30 stocks but still be heavily concentrated in one investment philosophy.
So, diversify or concentrate?
Perhaps the answer is: neither blindly.
Diversification should be used to reduce risks that genuinely matter. Concentration should be used when conviction is high enough to justify meaningful exposure.
The objective is not to own everything. Nor is it to own only a handful of ideas.
It is to construct a portfolio where every position has a purpose, the level of risk is intentional and the investor can remain invested long enough for the strategy to work.
After all, the ultimate risk is not simply volatility.
It is losing capital, losing conviction and ultimately losing the ability to stay invested.
The best portfolio, therefore, may not be the one with the most stocks or the fewest.
It is the one where diversification and concentration are both used deliberately- to protect compounding rather than merely to make the portfolio look safer.
