The twenty-stock illusion
Adding more positions is not diversification. It is the most expensive illusion of safety.
#The "I have spread enough" feeling
An investor looks at the portfolio: twenty different rows. Relief sets in. But that relief usually rests on an image, not a measurement.
Diversification is not a counting exercise. Its measure is how independently your assets move from one another.
#The risk-driver idea
Every asset responds to one or a few drivers: interest rates, currency, commodity prices, economic growth, sector demand, regulation.
If two assets depend on the same driver, they carry the same risk even when their names differ.
So the right question is:
Not "how many assets do I have?" - but "how many different drivers am I exposed to?"
#A concrete example
Picture five bank stocks. Different companies, different management, different balance sheets. But they all:
- Respond to the same interest-rate decision
- Live in the same credit-risk environment
- Are subject to the same regulation
- Rise and fall with the same macro cycle
Your portfolio shows five rows; in risk terms you carry roughly one position.
#Two layers of risk
Splitting risk in two makes everything clear:
Buying twenty stocks reduces the first layer. It does nothing to the second - and the second is usually the one that truly hurts.
#Diminishing returns
The benefit of adding a position is not linear: the first few positions clearly lower company-specific risk, then the benefit fades fast. Past a certain point, a new position reduces risk almost not at all; it only raises your tracking burden and cost.
So the goal is not "as many assets as possible" but "as many different drivers as possible".
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