Anne Marie
In 1965, a 47-year-old lawyer named André‑François Raffray struck a deal to pay a 90‑year‑old woman 2,500 francs per month until her death, when her apartment would become his. Unfortunately for him, the woman was Jeanne Louise Calment, who lived to 122, the longest confirmed human lifespan on record. Raffray ended up paying the equivalent of $180,000, more than twice the apartment’s value. He died two years before Calment.
The lesson here is that even your most carefully calculated thesis can go completely sideways. There’s no such thing as a sure thing.
Savvy investors understand this. Stocks always carry risk—even giants like Alphabet (Google). Maybe there’s a 99.9% chance Alphabet will thrive over the next decade, but history is full of fallen titans. Think Lehman Brothers, Enron, Kodak, and General Motors.
Risk isn’t the enemy. In fact, it’s the price you pay for higher potential returns. What matters is how you manage that risk, and every great investor knows you can’t do that without diversification.
Diversification is the best defense against the unknown. It’s the only reliable way to protect yourself from surprises, whether it's a financial collapse or a 122-year-old woman.
Ideally, you should build a diversified portfolio over time, aiming to own between 10 and 30 stocks. The more you own, the more you spread your risk. But owning too many can dilute your returns and turn your portfolio into something that just mirrors an index fund.
Here are three key ways to diversify effectively.
How to Diversify Your Portfolio
There’s no great secret to portfolio diversification, but there are three essential dimensions every investor should consider:
1. Mix by Company Size
Start by buying a range of companies in different size brackets. Larger, more established companies carry lower risk. These are your bedrocks—the blue-chip names like Coca-Cola or Johnson & Johnson that can survive even when they stumble.
But if all you hold are bedrocks, your returns may be underwhelming. That’s why you also want to include smaller, less established companies with more growth potential. A small-cap tech startup might seem risky on its own, but in a portfolio alongside nine large-cap names, it adds upside without making the portfolio reckless.
2. Diversify Across Industries
Owning 30 stocks in the same industry isn’t real diversification. If that entire sector takes a hit, your portfolio will suffer.
As Jason Zweig put it, “That’s like thinking an all-soprano chorus can handle singing ‘Old Man River.’” To cover the full range of market dynamics, you need a mix of voices. Aim to spread your investments across at least three distinct sectors—tech, consumer goods, healthcare, energy, financials, or others.
3. Include Global Exposure
Don’t limit your portfolio to companies tied only to the U.S. economy. Companies with international revenue streams provide a built-in hedge.
For example, Coca-Cola sells products in almost every country on earth. It’s still exposed to a U.S. downturn, but far less than a domestic-only business like Chipotle. Look for global operators when you’re building your mix.
A well-diversified portfolio cushions you against shocks, gives you peace of mind, and increases your odds of holding that one stock that goes on to outperform everything else.
FAQ
How to Diversify a Stock Portfolio by Age?
A common guideline is the Rule of 110. Subtract your age from 110, and that number becomes your target stock allocation. For example, if you're 40, aim for 70% in stocks and 30% in bonds or other fixed-income assets.
This is just a starting point. Your ideal allocation depends on your goals, risk tolerance, and retirement timeline. Make adjustments to create a portfolio that lets you sleep well at night.
Why Diversify a Stock Portfolio By Age?
When you’re close to needing your money, a market drop can do real damage. It’s not just the financial hit—it’s the emotional stress. That’s what drives people to panic and sell at the worst possible time.
Age-based diversification helps prevent that. Younger investors can ride out volatility, so they can afford to stay heavily invested in stocks. As you get older, gradually shifting toward bonds and safer assets helps preserve your capital.
Keep any money you’ll need in the next five years in safe places—cash, CDs, or government bonds. Emergency funds should always sit in a savings account where they’re ready when you need them.
What Is the 70/30 Portfolio Strategy?
This strategy means allocating 70% of your portfolio to stocks and 30% to bonds or fixed-income assets. It’s a common balance for someone with moderate risk tolerance and a long time horizon. The goal is to capture market growth while softening the impact of volatility.
The exact mix can and should shift based on your age, goals, and how comfortable you are with risk.
What Is the 5% Rule for Diversification?
The 5% rule is simple: no single stock should take up more than 5% of your total portfolio. This keeps any one company from dragging down your results if it tanks.
It’s a disciplined way to reduce risk and ensure true diversification. You spread your bets and protect yourself from being too exposed to a single failure.