Diversification

Holding enough genuinely different assets that no single outcome decides your result. It reduces risk specific to individual holdings; it does not reduce the risk they all share.

Example

Ten independent holdings each with a one-in-five chance of total loss still lose about 20% of capital on average, but the chance of losing everything falls to roughly one in ten million.

Important

Count exposures, not line items. Thirty funds holding the same kind of company in the same market is one position with thirty names on it.

Related terms

• Unsystematic risk — Risk attached to one specific holding - a company failing, a building burning, a borrower defaulting, a product being recalled. Also called specific or idiosyncratic risk.
• Systematic risk — Risk shared by everything in a market - the economy, interest rates, inflation, currency, broad sentiment. Also called market risk.
• Correlation — A measure from +1 to -1 of how closely two assets have moved together over a chosen period. +1 is lockstep, 0 is no relationship, -1 is exactly opposite.

Lessons that explain it

• This belongs in the money you could genuinely lose, sized small, and held for reasons beyond the return — The apparent low correlation with financial markets is partly real and partly an artefact of how these assets are valued - and once round-trip costs and total-loss risk are honestly priced in, this asset class fits only as a small, patient allocation of money whose absence would not change anyone's plans. (10 min)
• Sometimes the only thing that rose, sometimes the thing that fell furthest — It genuinely protects a portfolio in some shocks and genuinely makes them worse in others, and the average of those two behaviours describes neither. That is the honest case, and it is a case for a small deliberate position. (10 min)
• A sized bet, renewed on purpose — If it belongs anywhere, it belongs as a position small enough that a total loss is survivable - and the diversification argument most often used to justify it has a habit of failing in exactly the weeks it is needed. (9 min)
• Why diversification works — Spreading money across many holdings does not raise your expected return. It changes the range of outcomes around it - and in particular it removes the ones you cannot come back from. (11 min)
• When concentration is the right call — Diversification is the correct default and it is not a law. The honest version of the argument is about what you would have to actually possess to justify departing from it. (10 min)
• The first ten holdings do most of the work; the next fifty do much less — Adding holdings reduces the damage any single failure can do, but the benefit falls away quickly. Beyond a point, more names add admin and dilute your best ideas without removing much risk. (10 min)

All 578 terms in the Investing glossary