Diversification

Don’t put all your eggs in one basket

Understanding how spreading investments reduces risk
Modified

September 7, 2025

Category: Investment Strategy
Difficulty: Beginner

Definition

Spreading your money across many different investments so that if one does badly, others might do well. This reduces your overall risk.

The Basic Concept

The old saying: “Don’t put all your eggs in one basket”

In investing: Don’t put all your money in one stock, one industry, or even one type of investment.

Why it works: Different investments do well at different times. When some go down, others might go up.

Simple Example

Bad diversification: - Put $10,000 into one tech stock - If tech crashes, you lose big

Good diversification:

  • Put $2,000 each into:
    • Tech stock
    • Bank stock
    • Healthcare stock
    • Real estate stock
    • Government bond
  • If tech crashes, you only lose on 1/5 of your money

Types of Diversification

1. Different Companies

Don’t buy just one stock: - Own 10+ different companies - If one company fails, others can succeed - Index funds do this automatically

2. Different Industries

Spread across sectors: - Technology: Apple, Microsoft, Google - Healthcare: Johnson & Johnson, Pfizer - Finance: JPMorgan, Bank of America - Consumer: Coca-Cola, Walmart

Why: When tech struggles, healthcare might do well

3. Different Countries

Go beyond just U.S. stocks: - U.S. stocks: Your home market - International developed: Europe, Japan - Emerging markets: China, India, Brazil

Why: Different countries have different economic cycles

4. Different Asset Types

Beyond just stocks: - Stocks: For growth - Bonds: For stability and income - Real estate: For inflation protection - Cash: For emergencies and opportunities

5. Different Company Sizes

Mix large and small companies: - Large companies: Stable, pay dividends - Small companies: Higher growth potential - Medium companies: Balance of both

Easy Ways to Diversify

Index Funds (Easiest)

Automatic diversification: - Total Stock Market Fund: Owns entire U.S. market - S&P 500 Fund: Owns 500 largest companies - International Fund: Owns foreign companies - Bond Fund: Owns many different bonds

Target Date Funds (Easiest++)

Everything handled for you: - Stocks, bonds, U.S. and international - Automatically adjusts as you age - One fund = complete diversification - Perfect for retirement accounts

Build Your Own

DIY approach: - 60% U.S. stock index fund - 30% international stock index fund - 10% bond index fund - Rebalance once per year

Common Diversification Mistakes

Over-Diversification

Too much of a good thing: - Owning 50+ individual stocks - Buying 20 different mutual funds - Complicated portfolio that’s hard to manage - Diminishing returns from additional diversity

Fake Diversification

Thinking you’re diversified when you’re not: - Owning 10 different tech stocks (still concentrated in tech) - Multiple funds that own the same stocks - Only owning U.S. stocks (missing international) - Only owning growth stocks (missing value stocks)

Home Country Bias

Overweighting your home country: - U.S. investors putting 100% in U.S. stocks - Missing opportunities in other countries - Extra risk from single country concentration

How Much Diversification is Enough?

For Individual Stocks

  • Minimum: 10-15 different stocks
  • Better: 20-30 stocks across different industries
  • Best: Just buy an index fund with hundreds of stocks

For Mutual Funds/ETFs

  • Simple: 3-4 funds (U.S. stocks, international stocks, bonds, maybe REITs)
  • Simpler: 1-2 funds (total market + international)
  • Simplest: 1 target date fund

Diversification and Returns

What Diversification Does

  • Reduces risk: Smooths out ups and downs
  • Doesn’t guarantee profits: You can still lose money
  • May reduce returns: Eliminates both big wins and big losses
  • Improves sleep: Less stress from volatility

What Diversification Doesn’t Do

  • Eliminate all risk: Market crashes affect everything
  • Guarantee profits: All investments can lose money
  • Beat the market: Average of many investments = average returns
  • Work instantly: Benefits show up over long periods

Diversification by Age

Young Investors (20s-30s)

  • Heavy stock focus: 80-90% stocks for growth
  • Some international: 20-30% of stocks in foreign markets
  • Minimal bonds: 10-20% for stability
  • Can handle volatility: Long time to recover from losses

Middle Age (40s-50s)

  • Balanced approach: 60-70% stocks, 30-40% bonds
  • Maintain international: Keep global exposure
  • Add stability: More bonds as you age
  • Reduce risk gradually: Less volatility tolerance

Near Retirement (60+)

  • Conservative shift: 40-60% stocks, 40-60% bonds
  • Focus on income: Dividend stocks and bonds
  • Preserve capital: Can’t afford big losses
  • Maintain some growth: Inflation protection

The Bottom Line

Diversification is the closest thing to a guarantee in investing. It won’t make you rich quickly, but it will protect you from being wiped out.

Simple rules: 1. Own many different investments 2. Spread across industries and countries
3. Include different types of assets 4. Use index funds for easy diversification

Remember: The goal isn’t to maximize gains, it’s to reduce the chance of big losses while still growing your money over time.

External Resources