Diversification
Why spreading your money across many companies, regions and asset classes keeps one failure from sinking your portfolio, and which risk it cannot remove.
Key idea
Diversification means not depending on any single investment. Own one company and a 50% fall halves your money; own a hundred and the same fall costs you half a percent. It protects you from the failure of a part, not from a fall of the whole market.
What it is
Diversification means spreading your money across many investments, so that no single one can do much damage. Companies fail, cut their dividends or fall out of favour, often without warning. If all your money sits in one of them, its bad news is your bad news. Spread across many, any one failure becomes a small dent.
When one company halves
Take CHF 10,000, split equally across a number of companies, and let one of them lose half its value. With 20 companies, for example, each holds CHF 500, so the fall costs you CHF 250:
| Companies Held | Portfolio After | Change |
|---|---|---|
| 1 | 5,000.00 | −50.0% |
| 10 | 9,500.00 | −5.0% |
| 20 | 9,750.00 | −2.5% |
| 100 | 9,950.00 | −0.5% |
The same bad news costs you half your money with one company and half a percent with a hundred. Nothing about the failing company changed, only how much of your money depended on it.
Three ways to spread
Diversification works on several levels at once:
Across companies
Many companies instead of a few, so one failure, scandal or bad product barely shows.
Across regions
Different countries and currencies, so one economy's slump isn't your whole portfolio's slump.
Across asset classes
Stocks and bonds behave differently. Bonds usually fall less in a crash and steady the whole.
The honest caveat
Diversification protects you against the failure of a part, not a fall of the whole. When the entire market drops, in a recession or a financial crisis, most stocks fall together, and a portfolio of a thousand companies falls with them. Spreading reduces company risk, not market risk.
Bonds often soften the blow, but not always: in some years stocks and bonds have fallen at the same time. And owning several funds isn't automatically diversified. Three world ETFs that hold largely the same companies are, in effect, one investment bought three times.
Swiss note
Investors everywhere tend to favour their home market, and Swiss investors are no exception. But Switzerland makes up only a few percent of the world's stock market, and the SMI is concentrated: a handful of giants, Nestlé, Novartis and Roche among them, carry a large share of it. Some Swiss shares can make sense, since they carry no currency risk, but a portfolio of only SMI stocks rests on a few companies and a few industries.
Key takeaways
- —Spreading money across many holdings shrinks the damage any single failure can do.
- —Spread across companies, regions and asset classes, not just across several funds that hold the same thing.
- —Diversification removes company risk, not market risk: in a crash most stocks fall together.
- —A broad index fund or ETF is the simplest way to own hundreds or thousands of companies at once.
Related concepts
Asset Allocation
Stocks, bonds and cash: the split that decides your ride.
Index Fund
Copy the market instead of trying to beat it, at a fraction of the cost.
Stock
Own a slice of a company and share in the profits it pays out.
Currency Risk for CHF Investors
Why a strong franc quietly eats into foreign returns — and when to hedge.
Asset Class
Stocks, bonds, cash and real estate each work in their own way.