The value of advice

Improved portfolio allocations can be achieved with help from a professional adviser, Vanguard researchers have found. Read our whitepaper ‘The value of advice: Improving portfolio diversification’ for more information about the important role advisers play in helping investors maintain well-diversified investment portfolios.

  • Diversifying investments helps to reduce portfolio volatility
  • Higher volatility can drag on portfolio returns
  • Concentrated portfolios risk missing out on market return drivers


By Jumana Saleheen, Chief Economist and Head of Investment Strategy Group; and Giulio Renzi-Ricci, Head of Asset Allocation, Vanguard Europe.

Diversifying investment portfolios is conventional wisdom for two fundamental reasons: risk and return. While the risk-reducing benefits of broad market diversification are generally well understood, less so are the return implications of diversifying your investments – or, more pertinently, failing to do so.

Starting with the risk aspect, most investors understand that holding a variety of non-perfectly correlated assets means they can shield their portfolios from unwanted volatility. The lower the correlation between the asset classes, the stronger the diversification benefits. This is one reason why, over the past 20 years, portfolios composed of equities and bonds have delivered strong risk-adjusted returns, since equity and bond returns have tended to move in opposite directions1.

Diversification within asset classes also makes sense from a risk perspective. It lowers the impact that large falls in any one security will have on the portfolio.

Portfolio concentration comes with more risk

Clients with a higher tolerance for risk, however, might be tempted by the idea that concentrating their investments could deliver greater returns if they can pick the best-performing investments.

Let’s take equities as an example. Empirically, the returns of a broad equity market index, such as the S&P 500, are driven by the high returns of a relatively small number of stocks.

Some investors might think that concentrated portfolios made up of their “best ideas” would be the surest path to equity market outperformance. The premise here is when a portfolio consists solely of a manager’s highest-conviction ideas, returns are undiluted by second-best or lesser ideas.

The reality is different, however, as our research shows that concentration reduces the odds of owning the few stocks that drive returns2. That is partly because it is hard to make successful investment calls, year after year. It’s also because if investors get their calls wrong, it is much harder to recoup those losses and start earning positive cumulative returns.

Put differently, the high level of volatility associated with holding a handful of stocks leads to a drag on performance, compared with a portfolio composed of a larger number of holdings.

Understanding the impact on returns

For example, imagine two portfolios, each with an initial value of £100: Portfolio 1, a low-volatility portfolio, achieves a 5% return in year one followed by a -5% return in year two; portfolio 2, a high-volatility portfolio, achieves returns of 40% followed by -40%. Both portfolios have an average return of zero. But what matters to investors is the compounded return. While portfolio 1 has largely recovered its losses by the end of year two, reaching a value of £99.75, portfolio 2 will be worth just £84. This impact of higher volatility on portfolio returns is often referred to as the “volatility drag”.

A simulation exercise that randomly selects stocks to create different-sized portfolio holdings shows that some portfolios outperform the benchmark while others underperform. However, concentrated portfolios are more exposed to the volatility drag.

For instance, based on our research, in randomly selected portfolios with five stocks, the average excess return on outperforming portfolios is 2.4%; but for underperforming portfolios the average loss is larger, at 3.8%. The impact of that volatility drag recedes as the number of stocks in the portfolio increases.

More diversification, less dispersion of average excess returns

Notes: Data covers the universe of stocks of the Russel 3000 Index from 1 January 1987 until 31 December 2017. The simulation exercise involves randomly selecting stocks to form different sized portfolio holdings. Our analysis assumes that a hypothetical investor would invest his or her capital over the entire sample period. Portfolios are rebalanced quarterly, and annualised average returns are presented separately for outperforming and underperforming portfolios for each portfolio size. For further details see Vanguard Research: “How to increase the odds of owning the few stocks that drive returns”, February 2019, C. Tidmore, F. M. Kinniry, G. Renzi-Ricci; E. Cilla.

Sources: Vanguard calculations, based on quarterly Russell 3000 Index constituents’ return data from Thomson Reuters MarketQA.


How much diversification is enough? Portfolios of ten or even 20 holdings are, in our view, too concentrated to give investors a decent chance of success. Only when a portfolio reaches 50 to 100 holdings do the odds move significantly in favour of returns.

Concentration can be bad for investors. It lowers the odds of owning the few stocks that drive returns; it also increases the odds of ending up with a highly volatile portfolio that could ultimately lead to poor performance. Diversification, by contrast, is conventional wisdom for good reason: it is an essential tool for reducing portfolio risk and it lowers the exposure of portfolio returns to the volatility drag.


1 Source: Vanguard research: Hedging equity downside risk with bonds in the low-yield environment, January 2021, G. Renzi-Ricci and L. Baynes.

2 Source: Vanguard Research: “How to increase the odds of owning the few stocks that drive returns”, February 2019, C. Tidmore, F. M. Kinniry, G. Renzi-Ricci; E. Cilla.

Investment risk information

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.

Simulated past performance is not a reliable indicator of future results.

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