Harry Markowitz is credited with the idea that diversification is “the only free lunch in finance”: it is the rare way to reduce risk without reducing, on average, the expected return.
Why it works
If you hold a single share and it collapses, you lose everything. If you hold fifty across different sectors, one falling is cushioned by the others. The key is that your assets do not all rise and fall at the same time: this is called low correlation.
Diversifying along several axes
- By security: do not bet everything on one company.
- By sector: technology, healthcare, energy, finance… do not react the same way.
- By geography: Europe, the United States, emerging markets.
- By asset class: equities, bonds, property, cash.
The limit
Diversification reduces specific risk (particular to one company), but not market risk (a crash drags everything down). A World ETF already diversifies the former enormously.
À retenir
- ✓Diversifying reduces risk at no cost in return: that is unique.
- ✓Its effectiveness comes from low correlation between your positions.
- ✓A broad index ETF is instant, inexpensive diversification.