Building a portfolio
Effective number of holdings
Also called Effective N
How many equally weighted holdings your portfolio behaves like, given how uneven the real weights are.
How it works
Counting rows overstates diversification when weights are lopsided. Effective N collapses the weights into a single number: twenty holdings where one is 60% of the portfolio behaves like far fewer than twenty.
It is computed as the inverse of the sum of squared weights, which is the same arithmetic as the Herfindahl index used to measure industry concentration.
Formula
Effective N = 1 ÷ Σ (wᵢ)², where wᵢ is each holding’s weight as a decimalWorked example
Four holdings at 70%, 10%, 10% and 10% give Σw² = 0.49 + 0.01 + 0.01 + 0.01 = 0.52, so effective N ≈ 1.9. Four names, behaving like two.
Related terms
- Concentration riskThe risk that too much of your outcome depends on one holding, sector, country or currency.
- DiversificationSpreading money across things that do not move together, so no single failure can decide your outcome.
- WeightHow much of your portfolio one holding represents, as a percentage of the total value.
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