Diversification is not about fonding - it's about choosing wisely

Copyright © HT Digital Streams Limit all rights reserved. Diversification is not about how many shares or funds you own – it’s about which Dhirendra Kumar 4 min Read 15 May 2025, 12:11 pm is the smart way to diversify your portfolio – without overdoing it. (Image: Pixabay) Summary More investments do not always mean more safety. This is why true quality diversification, not quantity, and how a simpler portfolio can provide better protection and peace of mind. When I browseed through X last week, I stumbled upon a yellowed outline from a 1996 edition of ABA magazine titled ‘Spreading the Wealth’. It was a setback for a slower era-long before robo advisors and trading programs. It made me think: How far have we really come to our understanding of diversification? The article, written by Jon Newberry, explained the maths of diversification with a clarity that often lacks in contemporary personal finance conversations. Despite all the advances in investment – smartphones, AI trading and world markets – the core principles of sound investment have not changed much since 1996. That old article was a timely reminder to me to review a topic I wrote about regularly: the true role of diversification in an investment portfolio. I often hear about readers who proudly describe their portfolios as ‘well diversified’. But when I look closer, many of these are simply long lists with possession – Dozens of individual stocks or mutual funds – which give the appearance of safety, while creating new problems. One striking example: An investor had more than 40 shares, but the top five accounted for more than 60% of the total value of the portfolio. The remaining 35? Too small to make a real difference, but still add complexity, paperwork and tension. Also read: Devina Mehra: Diversified or Concentrated Portfolio? This is an easy choice, it brings us to a fundamental question that too few investors ask themselves: What exactly is diversification intended to achieve? The basic premise is, of course, the protection against catastrophic loss. As investment legend Philip Fisher pointed out in 1958 (and as quoted in that ABA Journal piece), ‘too many eggs in so many baskets’ can have that many eggs do not end up in attractive baskets. Diversification is not just about quantity; It’s about intelligent risk management. The math of risk One of the most striking points from the article was a simple mathematical illustration. If a portfolio has only one security, there is a 33% chance – based on their example – that the entire investment can be wiped out. Add a second, uncorrelated security, and the risk drops significantly. With three uncorrelated possessions, the chance of losing everything to just 4%falls. By the time you have five well -selected securities, the risk of total loss drops below 0.5%. The exact figures may not last in the contemporary market, but the principle behind them remains powerful. However, this is where many investors misunderstand the diversification. They assume that more is always better. In fact, diversification comes with diverse returns. The leap of one to five shares produces a major reduction in risk. But the difference between 20 and 50 holds? Minimally at its best. Meanwhile, the cost – more time, more paperwork, more spiritual junk – stops to stack each new addition. Also read: If math errors cost more than money, the actual diversification is not just about quantity, but quality – to spread investments on assets that respond differently to different economic conditions. This means diversifying over business sizes (large, middle and small cap), sectors, geographical areas and even asset classes (stocks, fixed income, perhaps some commodities). An actual diversified portfolio may contain fewer individual securities than you would expect, but they are carefully chosen to complement each other. Keep it simple, a handful of well -chosen mutual funds can provide all the diversification needed for the average investor. A large cap, a mid/small cap and an international fund covers most bases to the shares. Add a debt fund for exposure to fixed income, and you have a robust portfolio with just four investments. Each fund already contains dozens of securities selected by professional managers, giving you the benefits of diversification without the administrative headache. Also read: Why is the diversification of assets class more important than ever? Peter Lynch, who ran the Fidelity Magellan fund, sometimes owned more than 1,000 shares. Lynch managed billions of dollars and had a team of analysts to help him track these investments. For the ordinary investor, the attempt to repeat this approach is not only unnecessary – it is counterproductive. Excessive diversification also has a significant psychological cost. If your portfolio contains dozens of possessions, it becomes virtually impossible to stay properly informed about each. This often leads to passive neglect of large parts of your investments – exactly the opposite of the particular, thoughtful approach that requires successful investment. I advocate a middle road when it comes to diversification – not too little, not too much, but just enough. For most investors, that lovely place lies somewhere between five and ten well -chosen investment vehicles. The goal is to balance risk protection with practical balance – enough diversification to guard against large losses, but still manageable enough to properly locate and evaluate. Also read: PMS vs Mutual Funds: How did portfolio managers perform with returns? It is also important to remember that diversification is no substitute for the necessary caution. A portfolio full of low-quality investments or overlapping investment-even if large in number-is no better than a smaller collection of carefully selected assets of high quality. When it comes to investment, quality always trumps the amount. In the end, effective diversification is not about spreading your money as widely as possible. It’s about putting it wisely. After a point, more investments do not increase your safety – it just increases your workload. And as on many areas of life, the simplicity is often the complexity when it comes to building a smart portfolio. Dhirendra Kumar is the founder and CEO of Value Research, an independent investment research firm that captures all the business news, market news, news events and latest news updates on Live Mint. Download the Mint News app to get daily market updates. More Topics #personal Finance #Money #Diversification #Mutual Fund #Portfolio Mint Special