ATLASDiversification
Investing glossary · Risk and statistics
Spreading money across assets that do not move in lockstep so that no single one can hurt the whole portfolio much.
Definition
Diversification means not putting all your eggs in one basket. By holding assets that do not move exactly together, the ups of some offset the downs of others, so the portfolio is less volatile than the average of its parts, without necessarily giving up expected return.
It works through correlation: the lower the correlation between holdings, the greater the benefit. It removes the risk specific to one company or sector, but it cannot remove the risk of the market as a whole. Owning many stocks in the same industry is less diversified than it looks.
Formula
σ_p = √( w₁²σ₁² + w₂²σ₂² + 2·w₁w₂·ρ·σ₁σ₂ )
w₁, w₂ = weights of the two assets; σ₁, σ₂ = their volatilities; ρ = their correlation. With ρ below 1 the portfolio's volatility is lower than the weighted average of σ₁ and σ₂.
Worked example
In the last year, NVIDIA had an annualized volatility of 33% and Coca-Cola 18%, with a correlation of -0.39 between their weekly returns. A 50/50 mix of the two had a volatility of about 15%, below the 26% average of the two stocks.
The gap between the mix and the average is the diversification benefit, and it grows as the correlation falls.
How ATLAS uses it
The Portfolio builder searches for mixes with the best odds of reaching a goal while limiting concentration, and the risk screen shows sector and position weights.
Related in ATLAS: Portfolio builder →Browse all ATLAS tools →See it on a real stock
The example above uses these companies. Open their pages for the full numbers:
Frequently asked questions
How many stocks do I need to be diversified?
Research gives different answers, from 20 to 50 or more, depending on how the stocks are chosen. Owning stocks across different sectors and countries matters as much as the number.
Does diversification protect me in a crash?
It reduces company-specific risk, but in a broad market fall most stocks drop together, so it does not remove market risk.
Related terms
Put the idea to work on your own stocks
Open any company in ATLAS to see its fair value, its odds of rising and its risk numbers side by side.
Try ATLAS →Not investment advice. ATLAS estimates are produced by statistical models from public data; they can be wrong and past performance does not predict future results. Consider your own situation before investing. Disclaimer