A small number of leading shares have performed incredibly well over recent years, with well-known tech giants dominating the US, and global, stock market.
Buying shares in one, or more, of these firms would have delivered significant returns, but would also have carried significant stock-specific risks.
Some inexperienced investors try to make big returns by holding just one or a few companies they like. If things go well, they can be richly rewarded, but they can also get their fingers seriously burnt if things go wrong.
Holding just one, or even a few, different securities means that a sudden piece of bad news could mean a significant loss to your wealth.
And, in investing, there is no such thing as a sure-fire winner. While underlying, fundamental, drivers of a business may be relatively stable, the market perspective on what value to assign to current, and expected, earnings can vary significantly through time.
Holding just one, or even a few, different securities means that a sudden piece of bad news could mean a significant loss to your wealth
Indeed, legendary investor Benjamin Graham stated that, in the short run, the market is a voting machine, but in the long run, it is a weighing machine. Long run fundamentals for businesses matter but, even high-quality companies can be hit by internal or external challenges that can send their share price tumbling.
Furthermore, there are few companies who have been able to continually navigate the challenges that technological change, and other factors, present through time.
This is where diversification comes in.
What is diversification and why does your portfolio need it?
Put simply, diversifying a portfolio means building a holding comprising differing underlying investments. In an equity portfolio, this can be a variety of company shares that are not all affected by the same drivers of return.
In a mixed asset portfolio, it will mean combining stocks with bonds, and potentially other assets, such as property and gold.
As the phrase goes: ‘Don’t put all of your eggs in one basket’.
Spreading your investments across (and within) assets with positive expected returns, but differing drivers for returns, means that you can be protected against poor performance of individual holdings.
Paul Niven, fund manager of F&C Investment Trust
F&Cs fund manager, Paul Niven, said: ‘Diversification isn’t just an investing principle – it’s a risk management tool. And in times like these, that matters more than ever.’
Instead of relying on a small number of securities, a diversified portfolio could have exposure to multiple companies, sectors, countries and even asset classes. This reduces the risk of a single investment or sector’s downturn having a big effect on your whole portfolio.
A more diversified portfolio also means that you may be cushioned against market volatility or political or economic events.
Furthermore, there has been well publicised work on ‘skew’ in the stock market (Bessembinder, 2018) which suggests that only a tiny subset of around 4 per cent of US companies are responsible for all the investment returns.
Indeed, between 1926 and 2016 more than half of US stocks actually lost money or did worse than short-dated treasuries – which is the equivalent of cash. Figures were even more pronounced in global markets with 61 per cent of companies losing money relative to cash and only 1 per cent of companies driving index returns.
The biggest risk for investors in equities is, arguably, missing exposure to those small number of companies which have an outsized impact on overall returns.
More focus reduces the chances of concentrating your capital on the winners while more diversification increases the chances of including future winners.
How diversified is too diversified?
Of course, you can have too much of a good thing. If your portfolio is too diversified, you may find that you aren’t seeing the gains you would hope as your exposure is spread too thinly. While only a small number of holdings drive equity market returns in the long run, a portfolio which is overly diversified will have a large exposure to the relative ‘losers’.
You might ask ‘how can a portfolio be too diverse?’, but the problem is less the number of investments you hold, but rather the issues that arise from going very broad and potentially doubling up holdings.
With a large portfolio of active funds, which aim to beat the market, investors might find that they are paying a premium for active management but have built a portfolio that has a closer resemblance to cheap tracker funds.
An unwieldy portfolio may also mean that many different fund holdings have significant crossover, especially when it comes to ETF trackers.
For example, holding separate global, US and tech funds would suggest a portfolio that is well spread. But in reality, a small number of US tech companies would be forming a significant part of such a portfolio.
Ideally, a diversified portfolio should be a mix of different types of investment, minimising the impact of any one of these facing a downturn
How diversified should your portfolio be?
There is no hard and fast rule that dictates exactly how focused, or diversified, your portfolio should be. More diversification is likely to lead to market level returns, while more focus introduces risk of missing out on the large winners which drive equity market returns in the long run.
Different assets also come with different levels of risk.
At one end, single stocks prove very high risk but could offer higher returns. On the other end, the likes of cash funds and bond funds offer much lower risk but also lower potential returns.
Ideally, a diversified portfolio should be a mix of different types of investment, minimising the impact of any one of these facing a downturn.
Niven said: ‘A diversified approach investing across multiple, focused strategies is more likely to capture the future winners in the market.’
By investing in funds you can outsource management of your exposure, with your assets spread across a range of investments at a low cost.
It is important to remember that not all funds offer broad exposure. Specialised funds and ETF trackers may be focused on single regions – such as S&P 500 ETFs that focus on the US, or on single sectors, such as defence or tech.
Capital at risk. The mention of any bonds or securities is not a recommendation to deal.
Approved February 2026 by Columbia Threadneedle Management Ltd.