by Skip Raschke

Created on: January 13, 2010   Last Updated: January 14, 2010

When it comes to portfolio diversification, you either must be diversified in some regard, or never, ever take your eyes off your portfolio!  For those who choose not to diversify, with all of their eggs are in "One Basket", they had better not "drop that basket".  Being diversified in a portfolio's holdings implies being mostly "long" (owning) securities via a variety of industries as well as financial instruments of each (common stock, preferred stock, bonds, long puts, short covered calls, etc).

The theory behind the principle of diversification is that by being so, one tends to be reducing risk while allowing for a slightly less reward relative to the aforementioned "One Basket" gambler. Beta is what a professional money manager relies on in order to control portfolio risk relative to a variety of portfolio holdings. Beta represents the potential return of a stock and/or portfolio relative to the financial market as a whole. The "One Basket" gambler will not be concerned with beta, instead "rolling the dice" as only gamblers do.

The "One Basket" gambler is accepting the fact that he/she is truly by definition, gambling.  The diversified portfolio by definition is not gambling, but instead, speculating. The difference between gambling and speculating lies in the numerical fact that the gambler almost Never has a 50-50 chance of winning. The speculator is on the correct side of the odds fulcrum, always having the odds at least 51-49 or better in his/her favor before "placing the bets".  70% of the movement of any stock is directly affected by the overall condition of the stock market. The remaining 30% pertains to the stock's underlying company and its economic performance, as well as the industry to which the stock is related. The "One Basket" gambler must have the stock market direction in his/her favor, the future of the "One Basket" company's financial performance in his/her favor, and the industry to which it belongs doing well and continuing to do so. Fall down on any of these 3 criteria and the "One Basket" gambler is in serious trouble.

As for portfolio diversification, the art if not mathematical science of doing so is predicated on knowing that diversification of a portfolio is governed by the proverbial "bell-shaped curve".  Thus even though the portfolio might be diversified, it might be diversified too much so! The optimal number of stock holdings within a portfolio should probably be about 10 stocks, each stock representing

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