Diversification

Diversification is the old advice about not putting all your eggs in one basket, carried into investing. Spread the money across several investments and no single disaster can floor you.

It is the cheapest way there is to reduce risk: it costs nothing and does not lower the expected return.

How it works

It is not only about the number. It is about whether your investments move together or independently.

When one investment falls and another happens to rise, the swings partly cancel. The whole is calmer than any of its parts: volatility falls without your having to give up return.

You can spread across several layers at once:

• across companies, not one business but dozens
• across sectors, not only technology, but healthcare, energy, consumer goods
• across regions, not only Europe, but the Americas and Asia
• across asset classes: shares, bonds, property

Why it matters

Diversification is the one thing in investing that improves the balance of risk and return without your paying for it. That is why index funds are so popular: one purchase buys hundreds of companies at once.

It protects you from what you cannot foresee. Nobody can say in advance which company will be in trouble in ten years but if you hold five hundred of them, you do not need to know.

What to watch out for

More investments does not automatically mean better diversification. This is the most common mistake. Buy ten technology companies and you have ten investments, but one bet. When a bad year for technology arrives, they fall together. Real diversification needs things that behave differently, not merely many things.

Overdoing it stops helping. Past a certain point, adding positions improves nothing and only complicates management. A couple of global funds do more than thirty individual shares.

Try it yourself

In the FIRE calculator you can see how a change in the expected return moves the whole plan and why a steadier average is worth more than a bet on a single card.