Diversification

Diversification means not putting all your money into a single investment. You might hold stocksTermStock×السهمA share of ownership in a company, bought and sold on a stock exchange, that may pay dividends and rise or fall in value.Open the term, bonds, real estate, and deposits instead of only stocks, or stocks from different sectors instead of companies in the same industry. The idea is that a loss in one holding may be offset by stability or gains in another, so the entire portfolio does not fall apart.

Because the most common way to hold a badly concentrated portfolio is to believe you have diversified it. Two funds with different names very often hold the same companies underneath: open the factsheet for each, compare the list of top ten holdings, and it is ordinary to find the same handful of names carrying most of both. Owning five funds like that is owning one position bought five times, with five sets of fees attached to it. That comparison takes about ten minutes and it is the single most useful check you can run on what you already hold.

The benefit also arrives early and then flattens out. Most of the reduction in risk comes from the first fifteen or twenty genuinely different holdings; the fiftieth adds almost nothing you could measure, while still adding a fee, a statement and a decision to make. And what survives all of it is the risk that cannot be spread — the kind that moves every asset in the same direction on the same day, which is precisely the day you would have wanted the protection. Diversification is insuranceTermInsurance×التأمينA contract where you pay a regular fee to transfer the financial risk of a specific event to a company that agrees to cover the cost if it happens.Open the term against being wrong about one thing, not against being wrong about everything at once.

• Diversification does not eliminate risk; it distributes it. In a broad crisis, all assets may fall together.
• Real diversification means investments that do not move in the same direction. Stocks from different sectors alone is not enough.
• Diversification increases costs: more management fees, transfer fees, taxes on each transaction. Account for these costs before deciding how many investments you actually hold.
• In smaller markets you may not find enough investments for true diversification, so you accept greater concentration.