Two kinds of risk
The first is permanent loss: a company fails or never recovers, and the money is gone. The second is volatility: prices swinging up and down along the way. Volatility is uncomfortable but survivable if you can wait. Permanent loss is not.
Spreading your money mostly protects against the first kind. One company failing barely matters if it is 2% of what you own. It matters enormously if it is 50%.
Why falls hurt more than rises help
Percentages are not symmetrical. If 100 falls by 50% you have 50. To get back to 100 you need a 100% rise, not 50%. A 20% fall needs 25% to recover. A 75% fall needs 300%.
This is why the size of the worst fall, often called the drawdown, deserves as much attention as the return. A portfolio that rises a lot but occasionally halves can leave you worse off than a steadier one, especially if you panic and sell at the bottom.
What diversification really means
Diversification is owning things that do not all rise and fall for the same reason. Twenty companies that all make computer chips are twenty companies and one bet. If chip demand drops, they all drop.
Useful spread comes from mixing industries, countries and types of business. A global tracker fund does this automatically, which is why it is the usual starting point.
Spotting concentration
Look at the weights, not just the list. A portfolio of thirty companies where the top three make up 60% behaves like a three-company portfolio.
A simple check is to add up the biggest five holdings. A simple fix is a cap: no company above, say, 8% or 10%. Equal weighting, where every company gets the same share, is the bluntest version of the same idea.
Time is part of the picture
Share prices can stay down for years. Money you will need soon, for a deposit or an emergency, should not depend on what the market does this year.
Over longer periods broad markets have historically been more likely to rise than fall, but that is a description of the past, not a guarantee, and it applies to broad markets far more reliably than to single themes.
Core and satellites
One common way people think about this is a large, boring core, such as a global tracker, with smaller amounts in themes they find interesting. If a theme goes badly, the core limits the damage.
How much goes where depends on your circumstances and is exactly the kind of decision a financial adviser helps with. Arithmos cannot make it for you.
The risks
- Diversification reduces the damage from any one holding. It does not prevent losses when whole markets fall.
- Themed portfolios are less spread out than broad funds, however many companies they hold.
- Spreading across countries adds currency risk: exchange rates move your returns too.
Try it yourself
The quickest way to understand a portfolio is to look at one. Here is how to turn this guide into something you can inspect.
- 1
Start from the idea
The button below opens the builder with this guide's idea already typed in. Change any part of it: the number of companies, the countries, the limit per company.
- 2
Read the reason for every company
You get a list of companies, how much of each, and a plain-English reason for each pick. If one looks wrong to you, you can ask for it to be changed.
- 3
Look at the bad years, not just the good ones
The portfolio is replayed against real past prices. Check the biggest fall along the way, and ask yourself whether you could have sat through it.
- 4
Decide for yourself
If you want to act on it, you buy the shares yourself through your own broker. Arithmos never holds your money or places trades.
“30 large companies from at least 8 different industries and at least 5 countries, the same amount in each.”
Browsing portfolios other people have published is free. See pricing for what building your own includes. A tested result is a simulation using past prices. It is not a forecast and not a recommendation.
Common questions
How many companies do I need to be diversified?
There is no magic number. A few dozen spread across different industries and countries captures most of the benefit. A handful, or many that all do the same thing, does not.
Is a themed portfolio risky?
It is more concentrated than a broad fund, because everything in it depends on one idea working out. That is why many people keep themes to a smaller part of what they invest.
What is a drawdown?
The fall from a high point to the following low point. The maximum drawdown is the worst such fall over a period. It tells you how bad the ride got, not just where it ended.
