Owning 10 stocks does not guarantee a safe portfolio. In fact, the words “guarantee” and “stocks” should seldom exist in the same sentence. However, owning many stocks in different sectors and industries will likely reduce portfolio volatility.
Company or individual security risk is the risk that a specific stock may fall in price due to non-market-related factors such as poor company management. This risk is in addition to the overall stock market risk and is not always rewarded with higher returns. You assume greater company risk when you invest in a limited number of securities. Including more securities in a portfolio can reduce the level of company-specific risk you are exposed to. This is true for stocks as well as other types of asset classes.
Diversification is a major benefit of investing in pooled accounts, such as exchange traded funds, mutual funds, closed-end funds or REITs. Even pooled accounts, however, cannot diversify away market risk. Market risk is the risk that the entire market will experience a decline in price. Even if you hold every stock in the market and have very little company-specific risk, you will still be exposed to market risk.
A number of studies have found that owning many stocks in different sectors and industries can reduce company specific risks, as illustrated here.¹
¹The portfolios used in this study are equally weighted. Other studies referenced include: Lawrence Fisher and James H. Lorie, “Some Studies of Variability of Returns on Investments in Common Stocks,” Journal of Business, April 1970; Edwin J. Elton and Martin J. Gruber, “Risk Reduction and Portfolio Size: An Analytical Solution,” Journal of Business, October 1977; and Meir Statman, “How Many Stocks Make a Diversified Portfolio?,” Journal of Financial and Quantitative Analysis, September 1987.