The Diversification Illusion: Why More Stocks in a Portfolio Do Not Automatically Mean Less Risk

• Individual Stock Diversification: Even very broad equity portfolios can be dominated by a small number of heavyweights
• Benchmark Dependence: Staying close to an index is no evidence of a balanced distribution of risk
• Economic Diversification: What matters are independent risk drivers, not merely the number of stocks

High valuations and the strong concentration in a small number of technology and AI companies are making global equity markets increasingly vulnerable to abrupt corrections. Institutions such as the European Central Bank and the International Monetary Fund have recently highlighted this risk. When a handful of companies account for an ever-growing share of the market, negative news, disappointed return expectations or price declines in individual stocks can quickly spill over to the broader market. This brings a perennial question back to the fore for investors: "Now tell me, what is your view on diversification?"
 

How Many Stocks Does a Diversified Portfolio Need?

A widely accepted rule of thumb states that the more stocks a portfolio contains, the better diversified it is. Indeed, company-specific risk initially declines significantly as additional stocks are added. However, concluding from this alone that investors should include as many individual stocks as possible in their portfolios falls short. "Although the number of holdings is relevant, in isolation it says little about the actual degree of risk diversification," says Daniel Jakubowski, Head of Equity Portfolio Management at Assenagon.

In their latest Assenagon study, Jakubowski and his colleague Sebastian Schmider, Head of AI Solutions & Macro Analytics, use a model calculation covering the past ten years to examine how diversification changes as the number of holdings increases. The two investment experts compare two types of portfolio: a market-capitalisation-weighted portfolio and a portfolio in which all stocks are equally weighted. The benchmark is a global, capitalisation-weighted investment universe comprising 1,268 stocks. The result: Under both approaches, the diversification effect initially increases as more stocks are added. However, there are considerable differences in how broadly capital and risk are actually distributed.
 

Why Benchmark Proximity Does Not Prove Genuine Diversification

As the number of holdings increases, capitalisation-weighted portfolios rapidly converge towards the broader market. Investors who hold the largest index constituents in proportion to their market capitalisation automatically replicate a substantial share of the index. However, a small deviation from the benchmark does not necessarily mean that capital and risk are evenly distributed. Even a portfolio that moves almost in lockstep with its benchmark can remain highly dependent on a small number of companies. "A broadly diversified portfolio is determined not only by the number of positions or its tracking error, but above all by the weight of its largest holdings and their contribution to overall risk," Schmider explains.

The complete global investment universe illustrates how misleading a sole focus on the number of holdings can be. Although the model calculation comprises 1,268 companies, just ten positions account for around 26% of the total weight of the capitalisation-weighted portfolio. These positions are also responsible for approximately 40% of the portfolio variance. "Risk concentration can therefore be even more pronounced than the concentration of portfolio weights alone would suggest," Jakubowski notes.
 

How Equal Weighting Reduces Concentration Risk

Equal-weighted portfolios present a different picture. Because each stock is initially assigned the same weight, dependence on individual large-cap companies declines significantly. Across the complete investment universe, the ten largest positions together account for less than 1%.

As the number of holdings increases, however, an equal-weighted portfolio diverges more substantially from the capitalisation-weighted overall index. Yet this deviation is not automatically a sign of insufficient diversification. “Instead, it demonstrates that benchmark proximity and risk diversification are two distinct portfolio characteristics,” Schmider says.
 

Three Dimensions Determine the Quality of Diversification

The study therefore distinguishes between three dimensions of diversification that should be considered when constructing a portfolio. Individual stock diversification describes the extent to which a portfolio depends on specific companies. In addition to the effective number of stocks, the key factors are the weights of the largest positions and the distribution of their risk contributions.

Benchmark dependence indicates the proportion of portfolio movements explained by the benchmark. Neither proximity to the benchmark nor deviation from it constitutes evidence of diversification in itself.

Economic diversification considers how broadly a portfolio is positioned across countries, sectors and factors. After all, even a large number of individual stocks may be exposed to similar economic forces and consequently behave in a similar manner during periods of market stress.
 

What Effective Diversification Means for Investors

Particularly in an environment of persistent geopolitical uncertainty, high valuations and concentrated equity markets, investors should not view diversification merely as a question of how many stocks a portfolio contains. "A portfolio comprising 250 carefully selected and evenly weighted stocks can be better diversified than a capitalisation-weighted global portfolio containing more than 1,000 individual stocks," the Assenagon experts explain. The decisive factor is not the maximum possible number of positions. What matters is which return and risk drivers are deliberately incorporated into the portfolio—and which concentration risks may arise unnoticed.

Read the full study in the latest edition of Assenagon Equity Insights.

Here you can download a print-quality photo of Daniel Jakubowski and Sebastian Schmider.

Munich/Frankfurt, 12 August 2026