Diversification: look beyond the number of investments

Diversification spreads investments across exposures rather than relying on a single investment or narrow group. Several funds can still hold many of the same companies, while several companies may depend on the same industry or economic conditions. Diversification can help manage risk, but it cannot guarantee that a portfolio will avoid losses. See the SEC's guide to asset allocation and diversification.

Consider a fictional investor who holds three funds with different names. Before describing the portfolio as diversified, the investor needs to understand what each fund owns. The names alone do not answer that question.

For an educational portfolio review, begin with a simple inventory. What does each investment hold? Which exposures overlap? What role was each holding intended to serve?

The exercise is about explaining the portfolio in plain language. If two holdings serve the same purpose, that may be intentional. If the overlap is a surprise, the investor has discovered a question worth exploring.

Asset allocation involves deciding how investments are distributed among asset categories. An appropriate allocation depends in part on the investor's time horizon and risk tolerance; there is no single mix suitable for everyone. The SEC's introductory guide explains these relationships.

Rather than beginning with a target number of holdings, begin with an explanation: what is this portfolio intended to achieve, and how do its parts support that purpose? A portfolio that can be explained is easier to question thoughtfully.