Neither Overconcentration nor Overdiversification, the 12-24 Rule

Simulated Growth: Concentration vs. the 12–24 Rule

Portfolio concentration has long been both the source of extraordinary returns and the downfall of many investors. The allure of betting heavily on a single standout company — say, a Broadcom or Nvidia — is undeniable: when the thesis works, returns compound rapidly. Yet the same concentration magnifies risk, exposing investors to company-specific volatility that even great fundamentals cannot fully hedge. As markets have become increasingly dominated by a small number of mega-cap winners, the debate between focus and diversification has only intensified.

This simulation examines the trade-off empirically by modeling three stylized strategies: a single-stock portfolio, a broad index exposure (cap-weighted, akin to the S&P 500), and a 12–24 stock equal-weight portfolio representing the so-called “12 Rule.” Each was simulated using a 10-year Monte Carlo forecast with realistic return and volatility assumptions. The goal was not to predict performance but to illustrate the relationship between concentration, diversification, and compounding efficiency over time.

The results reveal a clear hierarchy of outcomes. The single-stock portfolio offered the highest potential return but also the widest range of possible results — a true high-risk, high-reward profile. The broad index, by contrast, produced steadier but lower growth. Interestingly, the 12–24 stock portfolio consistently outperformed the index on a risk-adjusted basis, achieving much of the benefit of diversification without the drag of over-diversification. It’s a balance between conviction and risk control — the essence of intelligent portfolio construction.

Detailed Analysis

• Simulation setup:

  • Time horizon: 10 years (monthly steps).

  • Number of scenarios: 10,000 Monte Carlo paths.

  • Inputs: single-stock expected return (10.5%) with 33% volatility; index expected return (9%) with 18% volatility; equal-weight 18-stock basket with 33% individual volatility and 0.20 average correlation.

  • Results represent median growth of $1 invested.

• Interpretation of results:

  • The single-stock line (black) grows more slowly in the median case because high volatility reduces compounding efficiency, even with higher expected returns.

  • The index (blue) grows steadily with less dispersion, illustrating the stabilizing effect of broad diversification but at the cost of muted upside.

  • The 12–24 stock rule portfolio (gold) compounds faster than both, benefiting from reduced idiosyncratic risk while maintaining exposure to equity risk premium and active conviction.

• Investment implications:

  • Diversification is not linear — beyond a certain point, it protects but does not enhance.

  • A well-constructed 12–24 name portfolio captures the majority of diversification benefits while preserving alpha potential.

The strategy balances conviction (enough exposure to best ideas) and resilience (enough breadth to survive drawdowns).

The Power of Outliers: How a Few Stocks Drive Market Wealth

Stock market history is not a story of averages — it’s a story of extremes. A small number of extraordinary companies have created a disproportionate share of all investor wealth. Since 1990, firms such as Tencent, Tesla, Kweichow Moutai, and Broadcom have delivered sustained, exponential returns that dwarf the market’s overall performance. 

This is the phenomenon of positive skew: the vast majority of stocks deliver ordinary or even disappointing returns, while a select few generate the lion’s share of long-term gains.

The chart highlights this reality by comparing the annualized dollar-weighted returns of the world’s most successful listed companies since their inception (or 1990, whichever is later) against the S&P 500’s long-run average. 

While the index compounded at a robust 10.8%, the standout performers achieved two to three times that rate, translating into massive cumulative wealth creation for patient investors. Each of these companies benefited from secular tailwinds, defensible moats, and scalable business models — characteristics that allowed them to compound capital for decades.

The implications are profound. Concentrated exposure to these rare winners can transform portfolio outcomes, yet identifying them ex ante remains notoriously difficult. The very existence of such outliers explains both the appeal and the peril of concentrated strategies: they offer the possibility of generational wealth creation but carry significant risk if conviction is misplaced. This is where the 12–24 rule — a disciplined middle ground between focus and diversification — gains its strategic power.

Detailed Analysis

• Data source & context:

  • Returns represent annualized, dollar-weighted performance since each company’s listing or since 1990 (whichever is later).

  • Data sourced from ASU and S&P Global.

  • Includes some of the most successful global equities by compounded investor returns.

• Key observations:

  • Top performers (Tencent, Tesla, Moutai) delivered 30–38% annualized returns, exceeding the S&P 500 benchmark (10.8%) by a factor of three or more.

  • Even among global blue chips, dispersion is enormous — the spread between the best and median performer exceeds 25 percentage points per year.

  • U.S. tech leaders such as Broadcom, Nvidia, Amazon, and Apple continue to dominate the upper decile, underscoring the concentration of innovation-led growth.

• Strategic implications:

  • Markets are power-law distributed — a small handful of companies explain most long-term equity wealth.

  • Missing the top 5–10% of performers can materially erode total portfolio returns.

  • Balanced concentration (e.g., a curated 12–24 stock portfolio) allows exposure to potential outliers while controlling for idiosyncratic failure risk.

The findings reinforce the need for active conviction within disciplined diversification, not indiscriminate breadth.

Marginal Diversification Benefit: Overdiversification Does Not Improve Risk Aversion

Diversification is one of the few free lunches in investing — but only up to a point. The intuitive belief that “more stocks mean less risk” is true in principle, yet its benefits diminish sharply beyond a certain threshold. 

Once a portfolio holds enough independent positions to neutralize idiosyncratic risk, additional names contribute little to further volatility reduction. What remains is market risk — the broad exposure that no amount of diversification can eliminate.

The chart above models this relationship mathematically, using the standard portfolio volatility equation for equal-weighted holdings. Assuming an individual stock volatility of 33% and an average correlation of 0.2, portfolio risk drops quickly as holdings increase from one to a dozen, but the slope flattens soon after. By the time the portfolio reaches 12–24 stocks, nearly all of the diversifiable risk has been captured; moving to 50 or 100 holdings yields minimal additional protection.

This behavior explains why “overdiversification” — the tendency of mutual funds and institutional portfolios to hold hundreds of securities — can dilute performance without meaningfully reducing risk. At some point, adding another position no longer hedges exposure; it merely blurs conviction. Effective portfolio design lies not in owning everything, but in owning enough — and knowing where that threshold sits.

Detailed Analysis

• Modeling assumptions:

  • Individual stock annualized volatility: 33%

  • Average pairwise correlation: 0.20

  • Equal-weight portfolio of 1–100 stocks

  • Formula: p=σ×1n+(1-1n)ρ

  • Represents annualized portfolio volatility as a function of holdings.

• Key insights:

  • Steep early decline: Moving from 1 to 10 holdings reduces volatility by almost half — from ~33% to ~20%.

  • Flattening curve: Beyond 20 holdings, the volatility curve stabilizes near 15–16%, approaching market-level risk.

  • Diminishing marginal benefit: Each additional stock after ~24 adds <0.1% volatility reduction — practically negligible.

  • The shaded 12–24 stock range captures roughly 70–80% of the total diversification benefit available.

• Investment implications:

  • Overdiversification wastes analytical bandwidth and compresses potential alpha.

  • Concentration in the 12–24 name zone provides an optimal balance between risk control and return potential.

  • True diversification is qualitative, not just quantitative — it depends on correlation structure, not just the number of line items.

  • The data supports disciplined selectivity over index-like sprawl.

Market Concentration: The Rise of the Magnificent 7

The modern equity market has become increasingly dominated by a small cadre of mega-cap technology and consumer platform companies — collectively known as the “Magnificent 7.” This group — Apple, Microsoft, Alphabet, Amazon, Meta, Nvidia, and Tesla — has not only reshaped global innovation but also redefined the structure of market capitalization itself. 

What began as a gradual consolidation of leadership has evolved into a form of index concentration unseen since the early days of industrial America.

The chart above visualizes this concentration trend by comparing the combined market capitalization of the Magnificent 7 to the total capitalization of the S&P 500 over the past decade. In 2015, these firms represented roughly 11% of total S&P value, a large but manageable share. By 2025, that figure has climbed toward 34%, with the group’s aggregate market value swelling from $2.2 trillion to nearly $20 trillion, even as the total S&P market cap reached $58 trillion. The effect is structural: the U.S. equity index, often cited as a diversified benchmark, now derives much of its movement from a handful of stocks.

This concentration presents both opportunity and risk. On one hand, these firms anchor global innovation and profitability; on the other, their dominance makes passive investors increasingly dependent on the fortunes of a few. 

It blurs the line between diversification and disguised concentration — a dynamic that underscores why active portfolio design and selective diversification remain critical even within broad-based index exposure.

Detailed Analysis

• Data summary:

  • Period: 2015–2025 (projected through 2025).

  • Source: Motley and S&P market capitalization data.

  • The Magnificent 7 include Apple, Microsoft, Alphabet, Amazon, Meta, Nvidia, and Tesla.

  • Values shown in trillions of U.S. dollars (T).

• Key observations:

  • Explosive growth: The Magnificent 7’s combined market cap increased ninefold — from $2.2T in 2015 to $19.8T in 2025.

  • S&P growth lagged comparatively: Over the same period, the total S&P 500 market cap rose from $17.9T to $58.0T — just over threefold.

  • Rising concentration: The group’s share of total market value rose from ~11% to ~34%, implying that one-third of the index is now driven by seven stocks.

  • 2022 anomaly: A brief dip in combined market value during the 2022 tech correction demonstrates the inherent cyclicality of leadership concentration.

• Strategic implications:

  • The S&P 500 is no longer broadly balanced — its top seven names dominate index returns, sector weightings, and volatility dynamics.

  • Passive investors are more exposed to single-sector risk (technology/platform economy) than index construction suggests.

  • Active allocators must decide whether to embrace or hedge this concentration — either overweighting innovation or diversifying beyond the index’s built-in bias.

The trend reinforces the logic of the 12–24 Rule: even within a benchmarked framework, concentration must be consciously managed, not passively absorbed.

Sources & References

SSRN. Do stocks outperform treasury bills. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2900447

ASU. Stocks and diversification.https://wpcarey.asu.edu/department-finance/faculty-research/do-stocks-outperform-treasury-bills

SSRN. Overdiversificationhttps://papers.ssrn.com/sol3/papers.cfm

Official Data. S&P annualized returnshttps://www.officialdata.org/us/stocks/s-p-500/1990#:~:text=Stock%20market%20returns%20since%201990&text=This%20is%20a%20return%20on,%2C%20or%207.98%25%20per%20year.