Starting out
Diversification
Spreading money across things that do not move together, so no single failure can decide your outcome.
How it works
The point is not to own many things. It is to own things driven by different forces. Twenty companies in one industry, in one country, in one currency is one bet with twenty names on it.
Diversification reduces the risk specific to a company or sector. It cannot remove the risk shared by the whole market, which is why a diversified equity portfolio still falls in a crash — just less than the concentrated version.
Where it misleads people
Past correlations are not a promise. Assets that historically moved apart have a habit of moving together in the exact conditions where you were relying on them not to.
Worked example
A portfolio of ten technology shares and one of ten shares spread across technology, healthcare, energy, consumer goods and utilities can hold the same number of names with very different risk.
Related terms
- CorrelationA measure from −1 to +1 of how closely two investments move together.
- Concentration riskThe risk that too much of your outcome depends on one holding, sector, country or currency.
- Systematic riskRisk that affects the whole market and cannot be removed by holding more things.
- Asset allocationHow you divide money between asset classes — the decision that drives most of your long-run experience.
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Educational reference only. Nothing here is investment advice or a recommendation to buy or sell anything, and tax treatment depends on your own circumstances and the country you are in.