Diversification
Spreading your investments across many holdings so that no single one can sink your portfolio. The only free lunch in investing.
Diversification means owning many different assets so that the failure of any one of them is a small dent rather than a catastrophe. Owning 100 stocks is more diversified than 10. Owning stocks across multiple countries, sectors, and company sizes is more diversified than owning just US large-caps. Owning some bonds alongside stocks is more diversified still.
The benefit is asymmetric. If one company in a diversified portfolio goes to zero, the portfolio drops by 1% or less. If you'd had 100% of your money in that company, you'd be wiped out. The upside (if it had been a great winner) is also diluted — but the downside is bounded.
Index funds and ETFs are the most efficient way for individuals to diversify. A single broad-market index fund holds thousands of companies — you get diversification with one transaction and a very low expense ratio.
The common mistake is thinking diversification means owning many funds. Three S&P 500 funds aren't diversification — they're the same exposure three times. True diversification spans asset classes, geographies, and sectors.
See also
- Asset allocation — How you split your investments across asset classes — typically stocks, bonds, and cash. The biggest driver of long-term returns and volatility.
- Index fund — A mutual fund or ETF that holds every stock in a market index (like the S&P 500) instead of picking individual stocks. Cheap, diversified, boring — and that's the point.
- ETF (Exchange-Traded Fund) — A basket of stocks (or bonds, commodities) that trades on a stock exchange like a single stock. Most ETFs track an index.
- Risk tolerance — Your personal ability — both financial and emotional — to handle losses in your investments without panic-selling.
Ask Cashowa about diversification
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