The choice between a concentrated portfolio, holding a relatively small number of positions with meaningful individual weights, and a diversified portfolio, spreading capital across many holdings, represents one of the more genuine philosophical divides in investing. Both approaches have produced highly successful long-term track records, and both rest on defensible, if fundamentally different, assumptions about risk, skill, and what actually drives investment returns.
This guide examines the mathematics of how diversification reduces risk and why that benefit shows diminishing returns as more holdings are added, the case successful concentrated investors have made for their approach, position-sizing frameworks like the Kelly Criterion, and a practical framework for deciding where an individual investor’s own portfolio should sit on this spectrum.
Key Takeaways
- Diversification reduces portfolio-specific (idiosyncratic) risk, but this benefit shows sharply diminishing returns after a certain number of holdings.
- Academic research has found that a large majority of the diversification benefit from adding stocks to a portfolio is typically captured within the first 20-30 holdings.
- Concentrated investing rests on the idea that genuine, differentiated insight is diluted, not enhanced, by spreading capital across many lower-conviction ideas.
- Several of the most successful long-term investors in history have run notably concentrated portfolios relative to typical institutional diversification norms.
- The Kelly Criterion offers a mathematical framework for position sizing based on edge and odds, though it requires inputs that are difficult to estimate reliably in practice.
- Concentrated portfolios require significantly higher confidence in individual security research and analysis, since single-position risk is far higher than in a diversified approach.
- The right choice depends heavily on an investor’s genuine information or analytical edge, risk tolerance, and the time and resources available for individual security research.
Defining the Spectrum
There’s no single universally agreed threshold separating “concentrated” from “diversified” — the terms describe a spectrum rather than a binary choice. As a general reference point, portfolios holding somewhere in the range of 8 to 20 individual positions are commonly described as concentrated, portfolios holding several dozen to a few hundred positions are commonly described as diversified, and broad index funds holding thousands of securities represent the far end of the diversification spectrum.
The Mathematics of Diversification
Systematic Risk vs Idiosyncratic Risk
Total risk in an individual stock can be separated into two components: systematic risk (also called market risk), which reflects a security’s sensitivity to broad market movements and cannot be diversified away no matter how many holdings a portfolio contains, and idiosyncratic risk (also called specific or unsystematic risk), which reflects company-specific factors unrelated to the broader market — a product failure, a management scandal, a lawsuit — and which diversification can substantially reduce.
How Adding Holdings Reduces Idiosyncratic Risk
As more individual holdings are added to a portfolio, each with its own largely independent idiosyncratic risk, those individual risks tend to partially offset one another across the portfolio as a whole — a bad company-specific outcome in one holding is statistically less likely to coincide with simultaneous bad company-specific outcomes across every other holding, assuming those idiosyncratic risks are reasonably uncorrelated with one another.
The Diminishing Returns of Adding More Holdings
Where the Bulk of the Benefit Is Captured
A well-established body of research on portfolio diversification has generally found that the large majority of the risk-reduction benefit from adding individual stocks to a portfolio is captured within a relatively small number of holdings, commonly cited in the range of 20 to 30 stocks for a domestic equity portfolio, with the marginal risk-reduction benefit of each additional holding beyond that point becoming progressively smaller.
Illustrative Pattern
| Number of Holdings | Approximate Idiosyncratic Risk Remaining (Illustrative) |
|---|---|
| 1 stock | 100% (no diversification) |
| 5 stocks | Meaningfully reduced, but still substantial |
| 10 stocks | Further reduced; diminishing returns beginning |
| 20-30 stocks | Most idiosyncratic risk eliminated; further additions show sharply diminishing benefit |
| 100+ stocks | Idiosyncratic risk largely eliminated; portfolio behaves increasingly like the broad market |
This pattern is illustrative rather than a precise universal figure, since the exact numbers depend on the specific stocks chosen and the correlations among their idiosyncratic risks, but the general shape of the relationship — steep initial risk reduction followed by a pronounced flattening — is a consistently observed and well-documented pattern.
The Practical Implication
This diminishing-returns pattern is central to the concentrated investing argument: if most of diversification’s risk-reduction benefit is already captured well before reaching dozens or hundreds of holdings, then adding position number 50, 100, or 500 primarily dilutes the influence of an investor’s best, highest-conviction ideas in exchange for a comparatively small additional reduction in idiosyncratic risk.
The Case for Concentration
The Dilution Argument
Proponents of concentrated investing argue that genuine, differentiated analytical insight is a scarce resource — most investors, even skilled ones, can only identify a limited number of truly high-conviction opportunities at any given time. Spreading capital across many additional, lower-conviction positions beyond that core set of best ideas doesn’t add proportional value; it simply dilutes the portfolio’s exposure to the ideas the investor actually has the strongest evidence and reasoning behind.
The Historical Track Record of Concentrated Investors
Several of the most well-documented, long-term successful investors in history have run portfolios that would be considered notably concentrated relative to typical institutional diversification standards, often holding a relatively small number of core positions representing a substantial share of total capital. This track record forms a significant part of the empirical, if anecdotal, case for concentrated investing among its proponents — though it’s worth noting this reflects a form of survivorship bias in how such examples are typically discussed, since concentrated approaches that failed are naturally discussed far less often than those that succeeded.
The Skill Requirement
The concentrated approach rests heavily on the assumption of genuine analytical edge — the ability to identify mispriced securities more accurately than the broader market, on average, over time. Without that edge, concentration simply amplifies the impact of essentially random individual stock outcomes, for better or for worse, rather than translating into genuinely superior risk-adjusted returns.
The Case for Diversification
The Efficient Markets Argument
A significant body of research and market experience suggests that consistently identifying mispriced securities with genuine analytical skill is considerably harder than it appears, and that most individual investors, and even many professional fund managers, do not demonstrate a persistent, reliable edge over long periods once fees and trading costs are accounted for. Under this view, broad diversification isn’t a concession to a lack of skill — it’s a rational response to the genuine difficulty of reliably identifying that skill or that edge in advance.
Reducing the Risk of a Single Catastrophic Mistake
Diversification directly limits the damage any single poor decision, unforeseen company-specific event, or analytical error can inflict on overall portfolio results. A concentrated portfolio’s single greatest strength — amplifying the impact of correct high-conviction calls — is precisely mirrored by its single greatest weakness: equally amplifying the impact of incorrect ones.
Smoother, More Predictable Outcomes
Diversified portfolios tend to produce a smoother, more predictable range of outcomes over time, closely tracking broad market returns rather than depending heavily on the accuracy of a small number of specific individual security decisions — a characteristic that can be particularly valuable for investors with a lower tolerance for significant tracking deviation from the broader market, or a shorter time horizon that limits the ability to recover from a poorly performing concentrated bet.
Position Sizing Frameworks: The Kelly Criterion
What the Kelly Criterion Is
The Kelly Criterion, originally developed for gambling and betting applications before being adapted to investing, provides a mathematical formula for determining what fraction of capital to allocate to a specific opportunity, based on the probability of a favorable outcome and the magnitude of the potential gain relative to the potential loss:
Kelly Fraction = (Probability of Winning × Win/Loss Ratio − Probability of Losing) / Win/Loss Ratio
The Logic Behind It
The Kelly Criterion is designed to maximize the long-run compound growth rate of capital, specifically by identifying the position size that’s neither so small that it leaves meaningful expected value on the table, nor so large that a string of unfavorable outcomes risks catastrophic, difficult-to-recover-from losses to total capital — essentially formalizing an optimal middle ground between excessive caution and excessive concentration.
Why It’s Difficult to Apply Directly to Investing
The Kelly Criterion’s core practical challenge in an investing context is that it requires genuinely accurate estimates of win probability and expected payoff — inputs that are considerably easier to establish precisely in a controlled gambling context (like a known-odds casino game) than in real-world security analysis, where the “true” probability of a specific investment thesis playing out favorably is inherently uncertain and cannot be known with the same precision. Because of this, many practitioners who reference Kelly-style thinking in investing use a fraction of the full “Kelly” position size, sometimes called “fractional Kelly,” specifically to build in a margin of safety against the very real risk of overestimating one’s own edge or confidence.
Practical Position-Sizing Considerations Beyond Kelly
- Conviction level: Higher-conviction ideas, backed by more thorough and reliable research, may justify a larger position size than lower-conviction ideas.
- Correlation with existing holdings: A new position that’s highly correlated with existing concentrated holdings adds less genuine diversification value than one with more independent risk drivers.
- Liquidity: Larger positions in less liquid securities can be considerably harder to exit without meaningful market impact if the investment thesis doesn’t play out as expected.
- Maximum acceptable single-position loss: Setting an explicit cap on how much total portfolio damage any single position could realistically inflict, even in a worst-case, complete-loss scenario, provides a useful discipline regardless of the specific sizing methodology used.
Concentrated vs Diversified: Side-by-Side Comparison
| Feature | Concentrated Portfolio | Diversified Portfolio |
|---|---|---|
| Typical number of holdings | Roughly 8-20 positions | Several dozen to hundreds (or thousands, for index funds) |
| Idiosyncratic risk | Higher; individual position outcomes matter significantly | Lower; individual position outcomes largely wash out |
| Dependence on analytical skill/edge | High — outcomes closely tied to research quality | Lower — outcomes more closely track the broader market |
| Range of potential outcomes | Wider; greater potential for significant outperformance or underperformance | Narrower; more predictable, market-like outcomes |
| Research and monitoring burden | Higher per position; fewer positions to track in depth | Lower per position; more positions but typically less individual scrutiny needed |
| Risk of catastrophic single-position loss | Meaningful; a single severe mistake can substantially affect the portfolio | Limited; any single position represents a small fraction of the total |
A Middle Ground: Core-Satellite as a Practical Compromise
Rather than choosing exclusively between fully concentrated and fully diversified, many investors adopt a structure that blends both, discussed in more detail in dedicated core-satellite portfolio strategy coverage: a broad, diversified core representing the majority of the portfolio, combined with a smaller, more concentrated set of satellite positions representing an investor’s highest-conviction individual ideas. This structure directly addresses the core tension discussed throughout this guide — it captures most of diversification’s risk-reduction benefit for the bulk of the portfolio, while still allowing genuine conviction to be expressed at a scale that isn’t diluted into irrelevance, but is also explicitly sized to limit the damage from any individual satellite position that doesn’t work out.
How to Decide Where You Should Sit on This Spectrum
Honestly Assess Your Genuine Analytical Edge
Concentrated investing’s case rests entirely on the presence of genuine, differentiated analytical skill or informational advantage. An honest, critical assessment of whether that edge genuinely exists — rather than simply assuming it does — is the single most important input into this decision.
Consider Your Time and Resources for Research
Meaningful concentration requires correspondingly deep, ongoing research and monitoring of each individual position, since each holding represents a much larger share of total portfolio risk. Investors without the time or resources for this level of individual security research are generally better served by a more diversified approach.
Evaluate Your Tolerance for Significant Underperformance Risk
Concentrated portfolios carry a meaningfully wider range of potential outcomes, including a real possibility of significant underperformance relative to the broader market if individual theses don’t play out as expected. Investors with a lower tolerance for that kind of outcome, or a shorter time horizon that limits the ability to recover from it, are generally better served by broader diversification.
Consider a Blended Approach
For many investors, a core-satellite structure, or simply a diversified portfolio with a modest allocation deliberately set aside for a small number of higher-conviction individual positions, offers a practical way to participate in the concentrated investing philosophy without fully committing a large portfolio to its considerably wider range of potential outcomes.
Frequently Asked Questions About Concentrated vs Diversified Portfolios
How many stocks are needed for a diversified portfolio?
Research on diversification has generally found that the majority of risk-reduction benefit from adding stocks is captured within roughly 20 to 30 holdings, with further additions beyond that point showing progressively smaller marginal benefit, though the exact figure depends on the specific stocks and their correlations.
What is the main argument for concentrated investing?
The main argument is that genuine, differentiated analytical insight is scarce, and spreading capital across many lower-conviction positions dilutes exposure to an investor’s best ideas without proportionally reducing risk, since most diversification benefit is already captured well before reaching dozens of holdings.
What is the main argument for diversification?
The main argument is that consistently identifying genuinely mispriced securities is considerably harder than it appears, and broad diversification limits the damage any single poor decision or unforeseen event can inflict on overall portfolio results, producing smoother, more predictable outcomes.
What is the Kelly Criterion?
The Kelly Criterion is a mathematical formula for position sizing based on the probability of a favorable outcome and the magnitude of potential gain versus loss, designed to maximize long-run compound growth, though it requires probability estimates that are difficult to establish reliably in real-world investing.
Is concentrated investing riskier than diversified investing?
Yes, in the sense that concentrated portfolios carry higher idiosyncratic risk and a wider range of potential outcomes, including greater potential for both significant outperformance and significant underperformance relative to a diversified, broad-market approach.
Can an investor combine concentrated and diversified approaches?
Yes. A core-satellite structure, combining a broad diversified core with a smaller, more concentrated set of high-conviction satellite positions, is a common way to blend both approaches within a single portfolio.
Do successful concentrated investors prove that concentration works?
Well-documented successful concentrated investors form part of the case made for the approach, but this evidence should be considered alongside survivorship bias, since concentrated approaches that failed are naturally discussed far less often than those that succeeded.
Final Thoughts
The concentrated versus diversified debate ultimately comes down to a single, honest question: does a genuine, differentiated analytical edge actually exist, and is it reliable enough to justify amplifying its influence on portfolio outcomes rather than diluting it? Diversification’s mathematics are clear and well-documented; concentration’s case rests on an assumption about skill that’s considerably harder to verify in advance than after the fact. Neither approach is universally correct — the right answer depends on a clear-eyed assessment of edge, resources, and genuine tolerance for a wider range of outcomes.
Diversification protects you from being wrong. Concentration rewards you for being right — but only if you actually are, and that’s a much harder thing to know in advance than most investors assume.
