JurnalPost.com - Holding many stocks in a portfolio is often considered the safest way to reduce investment risk. The more stocks purchased, the smaller the potential loss. However, is this assumption always correct?
Imagine an investor placing all their funds into ten banking stocks. They feel they have diversified because they own many different stocks. Meanwhile, another investor buys only four stocks from different sectors.
When the market comes under pressure, the investor with ten stocks is not necessarily in a safer position. Conversely, the investor holding only four stocks could potentially have a lower-risk portfolio.
This phenomenon can be explained through the modern portfolio theory introduced by Harry Markowitz in 1952. This theory asserts that the success of diversification is not determined solely by the number of stocks, but also by the relationship between the price movements of the assets held.
In other words, investing is not just about choosing stocks with the potential for high returns, but also about how to combine a number of assets so that risk and return can be managed optimally.
Diversification Is Not Just About Increasing the Number of Stocks
In the world of investing, diversification is a strategy of allocating funds across several assets to reduce dependence on a single source of risk. However, buying many stocks does not automatically result in a well-diversified portfolio.
What needs to be considered is correlation, which is a measure that describes how closely the movements of two assets are related.
If all stocks in a portfolio tend to rise and fall together, the benefits of diversification become limited. Conversely, a combination of stocks with movements that are not entirely in the same direction can help suppress overall risk.
As an illustration, consider two stocks that each have a risk or volatility level of 20 percent. The investor then divides their funds equally, 50 percent each.
The results can differ depending on the correlation of the two stocks.
Correlation +1: Both stocks move entirely in the same direction, so the portfolio risk remains at 20 percent.
Correlation 0: The movements of the two stocks have no linear relationship, so the portfolio risk drops to approximately 14.1 percent.
Correlation −0.5: Both stocks tend to move in opposite directions, so the portfolio risk drops to approximately 10 percent.
This hypothetical calculation shows that two portfolios with the same number of stocks and fund allocation can have different levels of risk.
This is one of the important principles in Markowitz's theory. Choosing a combination of assets can have a major influence on portfolio risk, even when the risk characteristics of each individual stock remain unchanged.
However, diversification still has limitations. This strategy primarily helps reduce company-specific or sector-specific risks, whereas systematic risks that affect the market as a whole, such as economic crises, interest rate changes, and geopolitical turmoil, cannot be completely eliminated.
Understanding the Efficient Portfolio in Markowitz's Theory
The main concept in Markowitz's theory is efficient portfolio or an efficient portfolio.
A portfolio is called efficient if it is able to provide the highest level of return at a certain level of risk, or offers the lowest risk for a predetermined target return.
In investment analysis, a collection of efficient portfolios is depicted through a curve known as the efficient frontier.
The curve shows the best combination of risk and potential return based on the assumptions and data used in the calculation.
Meanwhile, portfolios that fall below the efficient frontier are considered suboptimal because there are alternatives that offer higher returns at the same level of risk, or lower risk for an equivalent level of return.
This principle shows that investment decisions should not be based solely on which stocks are expected to provide the highest returns.
Investors also need to consider whether the additional potential return is worth the risk that must be borne.
Example of Markowitz Application on Indonesian Stocks
The application of Markowitz's theory can be found in research by Ridwanudin and Sari (2023) which analyzed IDX30 member stocks, namely Bank Negara Indonesia (BBNI), Astra International (ASII), and Adaro Energy Indonesia (ADRO), using 12 months of data during 2022.
The study formed a number of portfolio combinations consisting of two stocks. Two of the combinations provide an interesting picture of the relationship between risk and return.
A portfolio consisting of BBNI and ADRO stocks with a composition of 30 percent and 70 percent respectively produced an average historical return of approximately 4.4 percent per month with a risk level of 8.49 percent.
Meanwhile, a portfolio of ASII and ADRO with a composition of 18 percent and 82 percent produced an average return of approximately 4.2 percent per month, but had a higher risk, namely 9.18 percent.
The comparison shows that the BBNI–ADRO portfolio is superior in both indicators. The average return is higher, while the risk level is lower.
Within the Markowitz framework, the ASII–ADRO portfolio can be categorized as a portfolio dominated by the BBNI–ADRO alternative in that comparison.
Another interesting finding is that the risk level of the BBNI–ADRO portfolio of 8.49 percent is lower than the risk of ADRO stock when held individually, which is approximately 9.7 percent.
Even though the historical return levels of both are not too far apart, approximately 4.4 percent and 5.0 percent per month respectively.
This result is an example of how a combination of stocks can suppress risk even though the correlation between the analyzed stocks is still classified as positive, namely around 0.60 to 0.71.
This means that two stocks do not have to move in opposite directions to provide diversification benefits. As long as their movements are not entirely identical, there is still an opportunity to reduce risk.
However, the results of this study need to be understood with caution. The data used only covers 12 months throughout 2022, when the coal sector experienced different market conditions compared to other periods.
In addition, the profile of the issuer ADRO has undergone changes. At the end of 2024, the company obtained shareholder approval to change its name to PT Alamtri Resources Indonesia Tbk, while its thermal coal business was separated into PT Adaro Andalan Indonesia Tbk (AADI).
Thus, the characteristics of the stock with the code ADRO currently cannot be directly equated with the company's condition during the research period.
The Best Portfolio Depends on the Investor's Goals
Other research was conducted by Silviani, Puspitasari, and Irawan (2025) on Jakarta Islamic Index (JII) stocks for the 2019–2024 period.
The results of the study show that different investment goals can result in different portfolio compositions.
When optimization is directed at obtaining maximum returns, the portfolio produces an average historical return of approximately 1.08 percent per month with a risk level of 6.26 percent.
Conversely, when the main goal is to minimize risk, the average return drops to approximately 0.44 percent per month with a risk of 4.37 percent.
This difference shows that there is no single portfolio that automatically becomes the best choice for all investors.
Investors with high risk tolerance may be willing to face greater fluctuations in pursuit of potential profits. Meanwhile, investors who prioritize the stability of investment value tend to choose portfolios with lower risk.
Therefore, portfolio construction should consider financial goals, investment time horizon, liquidity needs, and the ability of each investor to face losses.
Why Are Optimization Results Not Always Accurate?
Although Markowitz's theory is an important foundation in modern investment management, its application is not free from a number of weaknesses.
One of the main problems lies in the use of historical data to estimate future conditions.
Portfolio calculation requires estimates of returns, variances, and covariances between assets. In fact, all these parameters can change following market conditions.
Michaud (1989) explains that Markowitz optimization has weaknesses because it can amplify the impact of estimation errors. Stocks that are accidentally estimated to have returns that are too high have the potential to receive excessive investment weight.
Findings by Chopra and Ziemba (1993) also show that errors in estimating average returns can have an impact about ten times greater on optimization results compared to errors in estimating risk.
The problem is that estimating future stock returns is one of the most difficult challenges in investment analysis.
In addition, optimization results sometimes produce portfolios that are too concentrated.
For example, in research on JII stocks, the portfolio with the goal of maximizing returns allocated approximately 93.4 percent of funds to only three stocks, namely ICBP, ADRO, and ANTM.
This concentration can increase the impact of losses if one of the stocks experiences a significant decline.
Research by DeMiguel, Garlappi, and Uppal (2009) even found that a simple diversification strategy by dividing funds equally across all assets, or known as the 1/Nstrategy, is difficult to consistently beat by various optimization models when tested using data outside the estimation period.
These findings are a reminder that more complex investment models do not always provide better results in practice.
The Importance of Rebalancing in Maintaining a Portfolio
Building a portfolio is not a job that is finished after an investor buys a number of stocks.
As market prices change, the percentage of ownership of each stock can shift from the initial planned allocation.
For example, an investor has IDR 100 million in funds divided into three stocks with the following composition:
Stock A at 40 percent or IDR 40 million.
Stock B at 35 percent or IDR 35 million.
Stock C at 25 percent or IDR 25 million.
If the price of stock A increases by 50 percent, while the prices of stocks B and C do not change, the value of the stock A investment becomes IDR 60 million.
The total portfolio also increases to IDR 120 million.
However, this change causes the weight of stock A to rise to 50 percent, while the weight of stock B falls to approximately 29.2 percent and stock C to 20.8 percent.
This means that without making any transactions, the portfolio composition has changed from the original plan.
Increased concentration in stock A can make the portfolio risk different from the risk level initially desired by the investor.
To overcome this condition, investors can perform rebalancing, which is adjusting the asset composition back to approach the target allocation.
Adjustments can be made periodically or when the weight shift has exceeded the specified tolerance limit.
However, investors must also calculate transaction costs, including securities company commissions and applicable stock sales taxes. In Indonesia, stock sales transactions on the exchange are generally subject to a final income tax of 0.1 percent of the gross sales value.
Rebalancing that is too frequent has the potential to reduce investment returns due to increased transaction costs.
Five Things Investors Should Pay Attention To
Understanding Markowitz's theory does not mean every investor must perform complex mathematical calculations before buying stocks.
At the very least, there are five simple principles that can be applied to build a portfolio more rationally.
Do not just chase past returns. Stocks with high historical returns will not necessarily provide similar profits in the future. Also pay attention to their volatility and potential losses.
Consider the relationship between stocks. Cross-sector diversification can help reduce risk concentration, although stocks from different sectors may still move in the same direction.
Limit investment concentration. Determine the maximum allocation limit for one stock or sector so that losses in one asset do not overly affect the entire portfolio.
Adjust investments to your risk profile. A portfolio suitable for an aggressive investor is not necessarily suitable for a conservative investor.
Evaluate the portfolio periodically. Changes in prices, economic conditions, and financial goals need to be considered to adjust the investment composition.
These five principles can help investors make decisions based on more measurable considerations, not just following trends or other people's recommendations.
Conclusion
The modern portfolio theory introduced by Harry Markowitz provides an important lesson that investment success does not only depend on the ability to choose stocks with the highest potential for profit.
Equally important is how to combine various assets to obtain an appropriate balance between risk and return.
Owning ten stocks is not automatically safer than owning four stocks. If all those stocks have almost the same risk characteristics and movement patterns, the benefits of diversification can be very limited.
Conversely, a portfolio with fewer stocks still has the potential to provide better risk management if the assets within it have complementary movement relationships.
However, investors should not consider optimization calculation results as a guarantee of profit. The stock market is constantly changing, while mathematical models remain dependent on the assumptions and quality of the data used.
Ultimately, a good portfolio is not a portfolio that always produces the highest profit, but a portfolio that is structured based on financial goals, risk-bearing capacity, and rational investment considerations.
Note: This article is prepared for educational purposes and is not a recommendation to buy or sell certain securities. The stock names and figures mentioned are examples based on historical data in the cited research. Past performance does not guarantee future investment results. The author declares no position in the stocks discussed. Every investment decision is the responsibility of the respective investor. Readers are advised to consider their personal risk profile or consult with an investment advisor licensed by the Financial Services Authority (OJK).
Bibliography
Chopra, V. K., & Ziemba, W. T. (1993). The effect of errors in means, variances, and covariances on optimal portfolio choice. The Journal of Portfolio Management, 19(2), 6–11.
DeMiguel, V., Garlappi, L., & Uppal, R. (2009). Optimal versus naive diversification: How inefficient is the 1/N portfolio strategy? The Review of Financial Studies, 22(5), 1915–1953.
Markowitz, H. M. (1952). Portfolio selection. The Journal of Finance, 7(1), 77–91.
Michaud, R. O. (1989). The Markowitz optimization enigma: Is 'optimized' optimal? Financial Analysts Journal, 45(1), 31–42.
Ridwanudin, O., & Sari, M. (2023). Penerapan model Markowitz dalam memperoleh portofolio optimal di pasar saham IDX30. Image: Jurnal Riset Manajemen, 11(1), 118–129.
Silviani, D., Puspitasari, E. Y., & Irawan, I. (2025). Analisis portofolio optimal menggunakan model Markowitz pada saham Jakarta Islamic Index periode 2019–2024. Jurnal Akuntansi & Keuangan Unja, 10(2), 226–232.
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