Diversification

The idea is captured in the saying "don't put all your eggs in one basket". If all your money is in a single company and that company fails, you could lose everything. If your money is spread across hundreds of companies, the failure of one has only a small effect.

Diversification works best when investments do not all move in the same direction at the same time. Shares in different industries, countries and company sizes respond differently to events. Bonds often behave differently from shares. Combining them smooths out the overall ups and downs.

For example, suppose half your portfolio is in airline shares and half in a company that runs video calls. A sudden drop in travel might hurt the airline but help the video company. Together, the portfolio is steadier than either holding alone.

Diversification reduces the risk linked to individual companies, but it cannot remove risk entirely. When the whole market falls, as in a severe recession, most investments fall together. This market-wide risk is called systematic risk. Low-cost index funds are a simple way for individual investors to diversify widely.