There is a particular kind of regret that comes from putting everything on one bet and watching it fail. It is not just the money. It is the feeling that you knew better, or should have, and chose to ignore it anyway. The voice that said "but this one is different" turns out to have been the same voice that has misled people for centuries.
Diversification is the antidote to that regret. Not because it guarantees success, but because it removes the possibility of ruin from a single mistake.
This article explains what diversification actually does, what it cannot do, and why the instinct to concentrate is so persistent despite the evidence against it.
This is general educational information, not personal financial advice.
The Core Idea#
Diversification means spreading investments across multiple assets, sectors, or regions so that no single failure can cause catastrophic loss.
The logic is simple: if you own ten things, and one of them fails completely, you lose 10%. If you own one thing and it fails completely, you lose 100%. The maths is not complicated. The psychology is.
The formal theory behind this is called Modern Portfolio Theory.¹ It shows that combining assets with imperfect correlation reduces portfolio volatility without proportionally reducing expected returns. In plain language: owning things that do not always move together smooths out the ride.
But the real value of diversification is not the maths. It is what it protects you from: the concentrated bet that felt right at the time and turned out to be wrong.
What Diversification Does#
It reduces the damage from being wrong about any single investment.
No one can reliably predict which company will fail, which sector will underperform, or which country's market will stagnate. Diversification accepts this uncertainty and builds a structure that survives it.
Research suggests that holding 30 to 50 stocks across different sectors captures most of the benefit of diversification.² Beyond that, additional holdings provide diminishing risk reduction. The first step away from concentration matters more than the fiftieth.
It reduces country-specific risk.
An Australian investor holding only Australian shares is exposed to the fortunes of a single economy. Australia represents roughly 2% of global market capitalisation. A portfolio concentrated entirely in one country is a bet, whether intentional or not, that this country will outperform.
It smooths returns over time.
Different asset classes perform differently in different conditions. When shares fall, bonds may hold steady. When domestic markets struggle, international markets may do better. A diversified portfolio experiences less dramatic swings, which makes it easier to hold through difficult periods.
What Diversification Does Not Do#
It does not prevent losses.
A diversified portfolio will still lose value in a downturn. During the 2008 financial crisis, almost every asset class fell. During the COVID crash of 2020, the same pattern repeated. Diversification reduces the severity of losses but does not eliminate them.
This is important to understand clearly. The investor who expects diversification to protect them from all pain will be disappointed, and that disappointment can lead to abandoning the strategy at exactly the wrong moment.
It does not prevent correlation spikes in crises.
In normal market conditions, different assets move somewhat independently. In crises, they often move together. Research shows that during severe market stress, correlations between assets increase dramatically.³ The things you thought were unrelated turn out to be connected when fear takes over.
This is not a flaw in diversification. It is a feature of markets. Diversification still helps (you lose less than an undiversified portfolio), but it does not provide immunity.
It does not guarantee outperformance.
A concentrated portfolio that happens to hold the right assets will outperform a diversified one. This is true by definition. The problem is that no one knows in advance which assets are the right ones. Diversification trades the possibility of spectacular success for the certainty of avoiding spectacular failure.
For most people, that trade is worthwhile. But it requires accepting that you will sometimes watch others do better, at least for a while.
Why Concentration Is So Tempting#
If diversification is so sensible, why do people concentrate?
Overconfidence. The belief that "I know this company" or "this sector is obviously going to win" is compelling. It feels like knowledge. Often it is just familiarity.
Narrative. A single investment comes with a story. A diversified portfolio is boring. Stories are emotionally satisfying in a way that statistics are not.
Short-term success. Concentrated bets sometimes work spectacularly, at least for a while. The investor who put everything in one stock and tripled their money tells everyone. The investor who did the same thing and lost 80% tends to stay quiet. Survivorship bias distorts perception.
Effort justification. If you spend hours researching a company, it feels wrong to allocate only 5% to it. The effort demands a bigger bet. But effort does not reduce uncertainty. It just makes concentration feel more justified.
None of these impulses are stupid. They are human. But they reliably lead to worse outcomes over time.
The Danger of "All-In" Decisions#
The most dangerous moment for a new investor is often the first investment. The instinct is to find "the best" option and put everything there. This feels decisive. It feels like conviction.
It is also the highest-risk approach possible.
Research shows that once a single holding exceeds 10-20% of a portfolio, volatility increases materially.⁴ Above 30%, diversification effectively ceases. The portfolio becomes a bet on a single outcome.
This is fine if you are right. It is catastrophic if you are wrong. And being wrong is more common than most people admit.
A more durable approach is to start diversified and stay diversified. Let time and contributions do the work, rather than trying to pick the one winner.
Diversification Across What?#
Diversification works across multiple dimensions:
Individual holdings. Owning many companies rather than few.
Sectors. Technology, healthcare, financials, energy, consumer goods. Each responds differently to economic conditions.
Geographies. Domestic and international. Developed and emerging. Different economies have different cycles.
Asset classes. Shares, bonds, property, cash. Each has different risk and return characteristics.
The more dimensions of diversification, the more robust the portfolio to any single source of risk. This does not mean owning everything. It means avoiding unnecessary concentration in any single dimension.
Correlation: The Hidden Variable#
Two assets are "correlated" if they tend to move together. Perfectly correlated assets provide no diversification benefit; when one falls, so does the other.
The problem is that correlation is not constant. Assets that seem uncorrelated in normal times often become correlated in crises. When markets panic, everything tends to fall together. Liquidity dries up. Fear spreads. The diversification that worked in calm periods provides less protection when it is needed most.
This does not make diversification useless. It makes it imperfect. An imperfect tool is still better than no tool at all. A diversified portfolio in a crisis will typically lose less than a concentrated one. But "less" is not "nothing."
Understanding this in advance is important. The investor who knows that diversification has limits is less likely to panic when those limits become visible.
A Note on Conviction#
There is a tension between diversification and conviction. If you truly believe something, why not bet heavily on it?
The answer is that conviction is often wrong. The feeling of certainty is not the same as actual knowledge. Markets are complex, information is incomplete, and the future is unknowable. Many people have been absolutely certain about investments that subsequently failed.
Diversification is not a lack of conviction. It is humility about the limits of prediction. It is the acknowledgment that even smart, informed, well-intentioned people are frequently wrong.
The investor who accepts this is not weak. They are realistic.
Summary#
Diversification reduces the impact of being wrong about any single investment. It works across holdings, sectors, geographies, and asset classes. It does not prevent losses, does not eliminate correlation spikes in crises, and does not guarantee outperformance. Concentration is tempting because of overconfidence, narrative appeal, survivorship bias, and effort justification. "All-in" decisions early in an investing journey carry the highest risk. Correlation between assets increases during market stress, reducing diversification's effectiveness precisely when it is most needed. The purpose of diversification is not to maximise returns. It is to avoid ruin, stay invested, and let time do its work.
Sources#
- Markowitz, H. (1952). Portfolio selection. The Journal of Finance, 7(1), 77-91. https://doi.org/10.1111/j.1540-6261.1952.tb01525.x
- Statman, M. (1987). How many stocks make a diversified portfolio? Journal of Financial and Quantitative Analysis, 22(3), 353-363. https://doi.org/10.2307/2330969
- Longin, F., & Solnik, B. (2001). Extreme correlation of international equity markets. The Journal of Finance, 56(2), 649-676. https://doi.org/10.1111/0022-1082.00340
- Petajisto, A. (2023). Concentration risk in stock portfolios. Forbes. https://www.forbes.com/sites/bill_stone/2025/06/15/concentrated-stock-positions-compounding-versus-risk/