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How money grows · Lesson 5 of 11

Diversification: Why Not to Put All Your Eggs in One Basket

Learn what diversification means, why single stocks are riskier than they look, and how spreading your money softens falls without removing them.

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THE WRITTEN LESSONFollow along at your pace

You have probably heard the saying: do not put all your eggs in one basket. In this lesson you see what it means for your money, why it matters so much, and where spreading stops helping. The idea has a proper name, diversificationdiversification: Spreading money across many investments, and across different kinds of investment, so that a fall in one has less effect on the whole. It reduces the risk tied to any single holding but cannot remove the risk of the whole market falling.Full entry in the glossary, and it is one of the most useful ideas in investing.

Two sellers at the beach

Picture a seller at the beach who sells only sunglasses. On rainy days they sell nothing. A seller who sells sunglasses and umbrellas earns something in any weather. That is diversification: spreading your money so one bad result hurts less.

Two beach sellers compared. Sunglasses only: on a sunny day, sales; on a rainy day, an empty jar and nothing. Sunglasses and umbrellas: sunglasses sell in the sun and umbrellas sell in the rain. A banner says One bad result hurts less.(opens the full-size picture)
Two products mean a rainy day no longer wipes out the seller.

Single stocks are riskier than they look

Spreading matters because single stocks are riskier than they look. One study followed almost 26,000 US stocks over 90 years. More than half did worse over their lives than safe government bills. And just 4 percent of them produced all the gains above what those bills paid. Finding those few winners in advance is very hard, which is why spreading your money across many companies is the usual starting point.

A grid of 100 small buildings, each standing for 1 of 100 US stocks from 1926 to 2016. Most are grey with red down arrows, a few are blue, and just a handful are orange with a coin. A caption says Just 4% of stocks made all the extra gains.(opens the full-size picture)
Most stocks lagged. A few made all the extra gains.

How many companies is enough?

So owning four or five stocks is not enough. Even a dozen carefully chosen ones is only a start. A fund that holds a whole market can own thousands of companies in one go.

Three baskets under the title How many companies is enough? 4 or 5 stocks holds 5 companies and is marked Not enough. A dozen holds 12 companies and is marked Only a start. A whole-market fund overflows with buildings and is marked Thousands of companies.(opens the full-size picture)
A whole-market fund spreads your money far wider than a handful of stocks.

Two ways to spread

You can spread money in two ways. The first is across kinds of investment, like stocks, bonds and cash, which often do not move together. The second is within each kind: across many companies, industries and countries.

Two rows. Across kinds, with the note Often don't move together, shows stocks, bonds and cash. Within each kind shows groups of buildings labeled Shops, Banks, Factories and Other countries.(opens the full-size picture)
Spread across kinds, and also within each kind.

Spreading has a limit

Spreading cannot remove every risk. It cuts the risk of one company failing, but not the risk of the whole market falling. In a crash, many markets tend to fall together, so even a well-spread portfolio can lose value for a while. So diversification softens the blow, but it does not remove it.

Two baskets compared. When one company fails, the basket's line dips only slightly and is marked Softened. When the whole market falls, three lines drop together and are marked Still falls. A banner says Softens the blow, does not remove it.(opens the full-size picture)
Spreading protects against one failure, not against a market-wide fall.

Watch for hidden piles

Also watch out for hidden piles. Several funds can hold the same big companies, so owning many funds may not spread your money as much as it seems. And if your job and a big part of your savings both depend on your employer’s shares, one bad year could hit both at once.

On the left, Fund A and Fund B hold the same orange buildings, labeled Same companies twice. On the right, a work badge labeled Your job and a coin stack labeled Your savings (shares) both point to one company building, next to a falling chart, labeled One company, two risks.(opens the full-size picture)
Overlap and employer shares can hide big concentrations.

YOUR TURN

This is general education, not personal advice. For your own decisions, see a regulated adviser.

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Read the full lesson script

You've probably heard the saying: don't put all your eggs in one basket. In this lesson, you'll see what it means for your money, and why it matters so much.

Picture a seller at the beach who sells only sunglasses. On rainy days, they sell nothing. A seller who sells sunglasses and umbrellas earns something in any weather. That's diversification: spreading your money so one bad result hurts less.

Spreading matters because single stocks are riskier than they look. One study followed almost 26,000 US stocks over 90 years. More than half did worse over their lives than safe government bills. And just 4 percent of them produced all the gains above what those bills paid.

So owning four or five stocks isn't enough. Even a dozen carefully chosen ones is only a start. A fund that holds a whole market can own thousands of companies in one go.

You can spread money in two ways. The first is across kinds of investment, like stocks, bonds and cash, which often don't move together. The second is within each kind, across many companies, industries and countries.

Spreading has a limit, though. It cuts the risk of one company failing, but not the risk of the whole market falling. In a crash, many markets tend to fall together, so even a well-spread portfolio can lose value for a while. So diversification softens the blow, but it doesn't remove it.

Also watch out for hidden piles. Several funds can hold the same big companies. And if your job and a big part of your savings both depend on your employer's shares, one bad year could hit both at once.

So remember: spread your money across many companies and different kinds of investment. Single stocks are riskier than they look. And spreading softens falls, but it doesn't stop them. Before the next lesson, list everything you already hold, like a pension, funds or shares, and note anything that's a big part of it. In the next lesson, you'll see how index funds let you own a whole market cheaply.