Why Spread It Out — the Intuition of Diversification
Everyone's heard the saying "don't put all your eggs in one basket." But surprisingly few people can properly explain why. Today let's grasp that intuition.
What Happens When You Go All-In on One Place
Suppose you put your entire fortune into one company's stock. If that company does well, it's a jackpot. But if that company suffers a "company-specific accident" like accounting fraud, a lawsuit, or losing to competition, your assets are shaken wholesale. In severe cases, you could lose most of your principal to a -80% drop or delisting.
By contrast, if you spread across many companies, many industries, many countries, and many assets (stocks, bonds, gold, etc.), even if an accident happens in one place, the rest hold up. Even if one falls -50%, if the others are fine, the total loss is much smaller.
This is the core of diversification. It's a trade that slightly lowers the "chance of winning big" in exchange for greatly lowering the "chance of going bust."
Diversification reduces the risk (idiosyncratic risk) from "an accident in a single asset." But it cannot eliminate the risk of the whole market collapsing (market risk).
Why Mix Things That "Don't Move Together"
Diversification's real power comes when you mix "assets that move differently from each other." For example, when the economy worsens, stocks fall, while safe assets (government bonds, gold, etc.) hold up or even rise. When you hold things that move in different directions together, one side acts as a cushion when the other collapses.
No matter how many things that move in the same direction (e.g., 10 stocks in the same industry) you hold, it's not true diversification. What matters is "how differently they move," not the number.
So it's more accurate to understand diversification not simply as "buying a lot" but as "mixing things with different characteristics."
What expresses in numbers how differently assets move is "correlation." The more you mix assets with low correlation, the greater the diversification effect.
よくある質問
Q. Doesn't diversification lower the return?
You may miss the "top return" from one stock skyrocketing. But the goal of diversification is not the top return; it's "going steadily while avoiding big losses." Considering that taking a -80% hit once requires +400% just to recover the principal, simply reducing large drawdowns can improve long-term outcomes.
Q. How many should I spread across to be enough?
There's no right answer, but dividing across asset classes with different characteristics (e.g., domestic and overseas stocks, bonds, real assets) matters more than the number. A single index fund or ETF automatically diversifies across hundreds of stocks, so an individual can get the diversification effect without picking stocks one by one.
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