Diversification: How Many Baskets Are Enough?

Everyone knows "don't put all your eggs in one basket." The less known part: you may think you bought ten baskets and have actually loaded them all onto the same truck.

Why It Works

A portfolio's risk is not the average of its holdings' risks — it is lower. The reason is simple: on any given day some rise while others fall, and the moves partly cancel out.

This is the closest thing to a free lunch in finance: you lower the swings without giving up expected return.

But Only If They're Independent

Real diversification happens across different axes:

The strongest of these is the third: stocks and bonds move together far less than two stocks do.

How Many Stocks Are Enough

The consistent finding of academic work: most company-specific risk disappears with 20–30 stocks. Beyond that, the benefit is small and the monitoring burden is large.

Correlation Rises in a Crisis

Diversification's most annoying property: it weakens exactly when you need it most. On panic days, investors sell not what they dislike but what they can sell. Assets that normally move independently fall together in the same week.

That doesn't mean diversification fails. It means "I'm diversified, I'm protected from drawdowns" is too optimistic. The protection is weak against short panics and strong against multi-year wrong bets.

When Concentration Makes Sense

Concentration isn't always a mistake; it can be a conscious choice. But it has three conditions:

• 01You genuinely know the company.
• 02You've priced the chance of being wrong and sized the position for it.
• 03You are not using leverage.

The third point is not negotiable. Concentration multiplied by leverage is the classic formula that blows up funds. More: What Is Leverage?