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What is Diversification?

Diversification is the practice of spreading investments across many uncorrelated holdings — different companies, sectors, countries and asset classes — so that the failure of any one cannot destroy the portfolio.

Diversification works because the future-return paths of different assets are not perfectly correlated. Holding 30 stocks instead of 3 reduces single-company risk by about 95% while keeping the expected return identical. Adding bonds, real estate and international equities further reduces total volatility because their drawdowns rarely coincide.

There are two kinds of risk: idiosyncratic (specific to one company) and systematic (market-wide). Diversification eliminates the first essentially for free; it cannot remove the second. Even a perfectly diversified equity portfolio fell 30%+ in March 2020 and 2008–09, because everything correlated to 1 in a crisis.

The cheapest way to be globally diversified is a single broad index fund such as MSCI ACWI (about 2,800 stocks across 23 developed and 24 emerging markets). For households with mortgage exposure or business ownership, the brokerage portfolio should tilt away from those concentrated risks — a Swiss banker should arguably underweight Swiss banks.

Example

Investor A holds CHF 100,000 in Credit Suisse alone; the stock falls 99% in March 2023, leaving CHF 1,000. Investor B holds CHF 100,000 in MSCI World ETF (Credit Suisse weight: 0.04%); the Credit Suisse hit costs roughly CHF 40 — the broader portfolio falls 1% on the day mainly from related sector pressure.

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Frequently asked questions

How many stocks for full diversification?+

Roughly 30 uncorrelated names eliminate most company-specific risk; broad ETFs hold hundreds at near-zero marginal cost.

Can you over-diversify?+

In principle yes, but for retail portfolios the benefits of broad diversification dominate the modest dilution of returns.

Does diversification work in crises?+

Equity correlations rise to nearly 1, but bonds and gold typically still rise — multi-asset diversification softens crashes.