Proper diversification: are five different shares enough?

A portfolio containing five different shares isn’t enough for effective risk diversification. But the principle is right. Investing in shares from different sectors and regions distributes risk because losses made on one company's shares can be offset by gains on others.

Investing everything in one single company means you’re entirely dependent on how well it performs. If it goes bankrupt, the money you invested is lost.

Global crises create risk

Investing in five different individual shares diversifies your risk a little, but not enough to protect your portfolio sufficiently against price drops in the wake of economic downturns, corporate scandals, trade conflicts or technological innovation, for example. Global crises can affect several sectors and regions at once.

There's no universally applicable rule about how many different corporate shares you should buy in order to be adequate diversified. As a rough guide, a portfolio should include shares from 20-25 companies. Distribution across industries, regions and sectors is more important than the number of shares in your portfolio. This can minimise your dependence on individual companies and thus fluctuations in their share price.

Focus on long-term goals

Investors should also add other asset classes, such as bonds or alternative investment vehicles, like real estate and gold, to their portfolio. The right mix depends on your willingness to take risks.

Generally speaking, the higher the proportion of shares, the greater the risk of value fluctuations in the portfolio.

Good impulse control

If you want to put your money into shares, you must keep track of developments on the market. You also need a certain amount of patience so as to avoid impulsively reacting to short-term market fluctuations.

Instead, you must take well-considered decisions based on long-term goals.

Funds offer broader risk diversification

Newcomers to the stock market are advised to invest through an actively managed fund, such as a Migros Bank strategic fund. Here, fund managers ensure professional asset management and continuously adjust the fund based on the relevant market conditions.

Money is invested in asset classes, such as shares, bonds or real estate, depending on the investor's appetite for risk. This spreads the risk more widely than when investing in individual companies.

Exchange-traded index funds (ETF) like MSCI World, which track a specific share index, are another option. MSCI World contains shares in about 1600 companies from 23 industrialised nations. It therefore also offers broad risk diversification.

Barbara Russo is a client advisor at Migros Bank.