Diversification
Diversification means not letting one company, or even a handful, decide your whole future.
The study
Hendrik Bessembinder studied every US listed stock from 1926 to 2016 and found that only about 4% of them created all of the stock market's net gain over Treasury bills. More than half of all stocks lost money over their lifetime.
What that means for a single bet
Picking one company to hold for decades is a bet that you found one of that rare 4%. Most people who try do not, not because they are careless, but because so few companies ever turn out to be big successes.
A worked example
Own one company and it goes to zero, and you lose everything. Own 100 companies equally and one of them goes to zero, and you lose 1% of your money. The business risk did not disappear; it got divided.
What it does not fix
Spreading across many shares removes the risk of one business failing, but not the risk of the whole market falling together, as it does in a crash. Diversification lowers one kind of risk, not every kind.
How it is usually done
A broad index fund owns hundreds or thousands of companies in one purchase, which is why it is the simplest way most people diversify: it is certain to own the rare big successes, along with everything else.
Key takeaways
- A tiny share of all stocks created almost all of the market's long-run gain; picking one is a bet you found one of them.
- Owning many holdings turns "one failure ruins me" into "one failure costs a small slice."
- Diversification does not protect against the whole market falling at once.