Unit 2 · Level 2 · Diversification
Diversification, reviewed
Diversification cuts risk without a matching cut in expected return, but only across assets that don't move together, and less than you'd hope in a true panic. It can't erase market-wide risk, it doesn't mean 'own lots of products', and it definitely doesn't mean betting your job AND portfolio on the same home economy. Free lunch: yes. All-you-can-eat guarantee: no.
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What you get asked
Match each unit-two concept to its essence
One idea and three traps. Diversify across things that differ (countries, asset classes) and look through fund names to what's underneath.
Which portfolio is the most diversified?
Two holdings can beat fifteen: the global fund spreads across companies and countries, and the bonds add an asset class that often behaves differently in stock crashes.
Diversification removes company-specific risk but can never remove ___-wide risk.
When the whole market falls, every diversified stock portfolio falls with it. That residual risk is precisely what stocks pay a long-term premium for.
Sofia works at a bank, owns a flat in the same city, and invests only in her country's bank stocks. Her core problem?
Her whole life is one concentrated bet on one sector in one economy: Nokia-era Finland in miniature. The portfolio is her one cheap chance to bet on something else.
What's the honest promise diversification makes for a crash like 2008?
In 2008 a global 60/40 portfolio fell far less than pure stocks, but it still fell. Expect the cushion, not a force field, and you'll never be disappointed into panic-selling. 🐜
The rest of this unit
The only free lunch in investing, and the fine print nobody reads.