Skip to content
Log in
← Glossary

diversification

Spreading money over many different investments so one failure does little damage to the whole.

Diversification means spreading money over many different investments so that one failure does little damage to the whole. If you own one company and it fails, you lose everything; if you own thousands, one failure barely shows.

It works because a large part of a single company's risk is its own: a bad product, a scandal, a lost market. Those risks cancel out across many holdings. What remains is market risk, the ups and downs every company shares, which no amount of spreading removes. Owning everything also means owning the rare big winners that drive most of the gains.

Diversification is about how different the holdings are, not how many funds you have. Ten funds in one country or one theme are still a concentrated bet. And it can fail when it is needed most: in some years stocks and bonds fall together.

Example

Ethan wants a "Top 10 picks" tab at Zapas. In a synthetic universe of 200 companies, a single company swings 36.3% a year; 5 companies 22.0%, 10 companies 19.2%, 30 companies 17.1%, all 200 16.2%, close to the market's 16% floor.

Over 20 years the index gained 235.4%, but the median company only 11.5%: 46.5% of companies lost money, and the top 10 (5%) produced 50.8% of the net gains. A beta user with 70% in one home stock fund and 30% in a theme fund earned 4.4% a year after inflation versus 5.9% for the world fund. All data is invented for the course.

Common mistakes

  • Owning many funds that all hold the same companies.
  • "Diversifying" inside one country, sector or theme.
  • Expecting diversification to prevent a market-wide fall.
  • Investments can fall, and you can get back less than you put in.

Learn it in the course