Diversification Explained

Diversification is one of the few 'free lunches' in investing. It reduces the impact of any single company or sector hurting your portfolio.

What Diversification Does

It helps reduce company-specific risk (e.g., a lawsuit, a bad product launch).

What Diversification Does Not Do

It does not eliminate market risk. In a broad selloff, most stocks can drop together.

Ways to Diversify

Across Companies

Holding multiple companies reduces reliance on any one business.

Across Sectors

Mix industries (technology, healthcare, energy, financials) so one sector slump doesn’t dominate returns.

Across Asset Classes

Consider including bonds, cash, or broad index funds depending on time horizon and risk tolerance.

The Simple Option for Most People

A low-cost broad index fund (like an S&P 500 or total market fund) provides instant diversification.

A Practical Checklist

1. Avoid making one stock > 10% of your portfolio (rule of thumb)
2. Prefer broad funds for the “core” of long-term investing
3. If you buy individual stocks, spread them across sectors

Summary

Diversification lowers the damage from single-stock failures. It doesn’t remove market risk, but it helps make outcomes more predictable.