Benjamin Graham — Warren Buffett's mentor — gave very specific instructions on capital distribution across grades of stocks within a portfolio.
Benjamin Graham — the founder of Value Investing — gave some very specific instructions on the subject of Position Sizing across various grades of stocks for optimum diversification.
Graham recommended a minimum portfolio size of 10 for Defensive grade stocks; or in other words, not more than 10% of one's portfolio per Defensive grade stock.
"Adequate though not excessive diversification... a minimum of ten different issues and a maximum of about thirty."
In keeping with the same principle, GrahamValue recommends a portfolio size of 20 for Enterprising grade stocks; or in other words, not more than 5% of one's portfolio per Enterprising grade stock.
This is due to the fact that Enterprising grade stocks have fewer qualitative requirements than Defensive grade stocks, but more than NCAV grade stocks.
Please note that Graham's own recommendation for this category was closer to 30 stocks, or not more than 3.3% per stock; but he leaves it to the Enterprising investor's judgment.
"If our winnowing approach had been applied to all 4,500 companies in the Stock Guide, and if the ratio for the first tenth had held good throughout, we would end up with about 150 companies meeting all six of our criteria of selection. The enterprising investor would then be able to follow his judgment—or his partialities and prejudices—in making a third selection of, say, one out of five in this ample list."
c. NCAV (Net-Net)
Graham also recommended a portfolio size of 30 for NCAV grade stocks; or in other words, not more than 3.3% of one's portfolio per NCAV grade stock.
"30 issues at a price less than their net-current-asset value."
As an example, one could distribute 100% of one's capital across:
- Five Defensive grade stocks (5 x 10% = 50%), plus
- Six Enterprising grade stocks (6 x 5% = 30%), plus
- Six NCAV grade stocks (6 x 3.3% = 20%)
Warren Buffett too has described the pros and cons of Diversification in great detail.
Graham also gave detailed instructions on capital distribution across Equity and Debt.
Buffett on Diversification
At the 1996 Berkshire Hathaway Annual Shareholders Meeting, Buffett gave the following explanation of how owning fewer stocks can be less risky if one knows what one's doing.
"There is less risk in owning three easy-to-identify, wonderful businesses than there is in owning 50 well-known, big businesses."
Buffett In 1962
Buffett is 32 years old here, and this is the first known recording of him.