Stock Market Diversification
In one of my previous articles (Investing in the stock
market -9 powerful tips), tip number one was:
1. Do not spread your money too thin.
My friend has a little over $200,000 invested in the stock
market through 27 different Mutual funds. In my opinion, 27
Mutual funds is 27 too many collecting load fees, management
fees, commission fees, operating and advertising fees.
Diversity is important, but just as important is
over-diversification. Also, in my opinion, $200,000 should
not be put into more than 12 stocks, let alone 27 different
Mutual funds.
If I may, I would like to explain where I’m coming from by
stating that tip.
On October 16, 1990 the Royal Swedish Academy of Sciences
awarded 3 men each a third of the Nobel Peace Prize for
their work in the theory of financial economics – Harry
Markowitz, Merton Miller and William Sharpe.
Harry Markowitz’s work involved the theory of portfolio
choice. (This in layman’s terms was the introduction of a
diversified portfolio to help offset the uncertainty and
risk of investing in the stock market. Harry Markowitz has
been labeled the ‘Father of Diversification’.
William Sharpe used Markowitz’s model from an individual
investment theory to a market analysis theory based on price
formation for financial assets. This formulation is called
Capital Asset Pricing Model (CAPM). From what I understand
about this model is that it places a “beta value” on a
share, the higher the beta value, the higher the risk.
By
knowing the ‘beta value’ of each stock in a portfolio, the
portfolio can be adjusted to either involve more or less
risk.
Merton Miller’s work involved dividends supplied by
companies to a shareholder and its effect on stock market
value and the effects of taxes. Miller’s theorems are used
for theoretical and empirical analysis in corporate finance.
Markowitz received his award for an essay published in 1952,
“Portfolio Selection” and for his book in 1959, Portfolio
Selection: Efficient Diversification.
Harry Markowitz, in his Nobel lecture given in 1990 says:
“an investor who knew the future returns of a security with
certainty would invest in only one security, namely the one
with the highest future return’.
Nowhere could I find that an investor should own 27
different mutual funds.
For more excerpts from the book ‘The Stockopoly Plan’ please
visit
http://www.thestockopolyplan.comCharles M. O’Melia is an individual investor with almost 40 years of experience and passion for the stock market. The author of the book ‘The Stockopoly Plan – Investing for Retirement’; published by American-Book Publishing. To order a copy of the book:
http://www.pdbookstore.com/comfiles/pages/CharlesMOMelia.shtmlCharles O'Melia
