Finding the right stock for your portfolio is important, but allocating the right amount of money to it is equally important if not more. Learn and understand the benefits and risks of diversification.

Benefits of diversification:

• Reduces the impact of volatility
• Stability & peace of mind
• Benefit from growth opportunities present in other sectors
• Makes investing fun

Over-diversification:

• Reduces return potential
• Becomes a hassle to manage
• Tax complications
• May increase the risk profile

Diversification is necessary to protect one’s portfolio from wild swings. Even though an investor has researched the stock very well and is very confident about the future of the company, there is a possibility that he might have missed something or some unforeseen factor or a black swan event impacts the future of the company negatively. Hence, one should be very careful while allocating too much money to a particular stock. The number of stocks one should hold will vary from person to person depending on their investment goal and strategy. But holding anything between 10 to 25 well-selected stocks is typically expected to give you enough diversification and anything more than that is typically considered over-diversification.

While some amount of diversification can protect the portfolio from wild swings, too much diversification can hamper overall returns. Eg: If you invest 1% of the portfolio in a stock and that stock becomes a 10-bagger overnight, your portfolio value will increase by around just 9%. While if you had a 5% or 10% allocation to that stock, the impact on your portfolio value would be significant. Allocating 10% or even 5% to a particular stock needs strong conviction on your side about the future of the company. Hence, one should do an ample amount of due diligence before allocating money to a particular stock. 

If your utmost priority is the safety of the capital, it might be better to consider investing in equities via ETFs (Exchange Traded Funds) or MFs (Mutual Funds). 

Below is a nice graphic version of the above information.