Chapter 7 · Mission 3 · 2000–2009

Diversification

Diversifying means spreading money across investments that don't move together.

Goes with Mission 3: Don't put all your eggs in one basket.

The idea

In short

1Diversifying means spreading money across investments that don't move together.
2Correlation measures whether two investments move together, from +1 (always together) to −1 (always opposite). Combining low or negative correlation is what helps.
3It's not about owning many things, but different things: 20 tech stocks are one bet repeated 20 times.
4Rebalancing: going back to your target mix from time to time. It makes you sell what rose and buy what fell.
5The limit: in a severe crisis many investments fall together. Diversification softens falls; it doesn't remove them.

In the data

What history shows

100% stocks, 100% bonds, or 60% stocks and 40% bonds, 1928–1949

The mix's worst fall was −60%, against −82% for stocks alone, and it ended at $30,449. Bonds cushioned the fall because they didn't move with stocks.

Real data, January 1928 to December 1949: years before any mission, so nothing is given away. Monthly returns from Robert Shiller and Aswath Damodaran.

Real figures

The numbers

Finish Mission 3 to see these real figures.

Remember

Takeaways

Finish Mission 3 to see the takeaways.

Practice, not scored

Quiz

1. Are 10 bank stocks diversified?

2. Your 60/40 has become 70/30 after stocks rose. What does rebalancing do?