Investment: How many Stocks should you own? (Part 2)

Click here for Part 1 of this post.

So the heck with diversification, right?

Well, not exactly.

First, the least-diversified investors frequently lagged the market; they just lagged by less than investors who held more stocks. Second, because stock returns are so uneven, the "average" undiversified investor doesn't really exist. At any given point, there are something like 10,000 stocks in the United States. Most of them are mediocre, but a handful are what Bill Bernstein of Efficient Frontier Advisers dubs "superstocks" capable of delivering gargantuan returns for years. Think Microsoft in the '90s, when it returned 9,000%. More often superstocks are lesser-known companies. (aC: This is so true; That is why my strategy is always to go after penny stocks with great fundamentals. You can buy more volume of stock A that's worth only $0.20 and wait for it to move to $1.20 as compared to a stock B that's worth $2.00 and watch it move to $3.00, even though the latter will usually move faster. With the same $10,000, you can buy 50 lots of stock A and reap $50,000 in gross profit as compared to 5 lots of stock B and gain just $5,000. Of course, the hard part lies in identifying those Stock As; Stock Bs are your typical Blue chips)

Across a large group of people whose portfolios are mostly in one or two stocks, the lucky few with superstock portfolios will make the group's average return look great, even if the vast majority of individual members have lousy or middling results.

On the other hand, investors who spread their bets across dozens of stocks have only a slightly better chance at catching a superstock. And if they do land one, it won't have nearly as much impact on their portfolios, or on the group's average return.

So the real story is that you need a lot of stocks to be adequately diversified, and you need a concentrated portfolio to give yourself a shot at striking it rich. An unsolvable catch-22? Hardly. In fact, you can have it both ways by employing a straightforward, two-part strategy.

First, direct 90 percent of your U.S. equity allocation into a total stock market index fund that automatically gives you a stake in thousands of companies. (aC: In Singapore terms, this will your ETFs that track indexes like your STI ETF 100) That guarantees you a piece of every superstock that already exists or might emerge later - and, more important, it means you'll be adequately diversified and your investing costs will be at rock bottom.

Then pursue your search for the next Microsoft or Google by researching the daylights out of a very small number of companies and putting the remaining 10 percent of your portfolio into your one to three best ideas. This way you'll let yourself have a little fun. You will also minimize your risk and maximize your hope.

(aC: Hmmm... I have a different recommendation here - I would recommend the allocation to be 70% ETF and 30% "undervalued penny stock". If it's 90/10 as recommended above, I dont think gains from the UPS portion will provide any meaningful offset to the market return of the ETFs.)