Diversification: Don't Put All Your Eggs In One Basket

Financially, diversification refers to allocating capital in a way to reduce your exposure to risk. You do this by diversifying your assets; that is, spreading your investments in a variety of assets. Asset prices never change in perfect synchrony, thus a diversified portfolio is less volatile. An example of a diversified portfolio is one with stocks, bonds, and obligations; an undiversified portfolio may hold just one stock.

The simplest explanation for diversification is the adage “Don’t put all your eggs in one basket.” Drop the basket, and all the eggs shatter. Place eggs in separate baskets, and if you drop one or two, the rest are still sound. There is risk of losing one egg, but less of losing them all.

Undiversified portfolios run large risks due to their susceptibility to market ebbs and flows. When you own one stock and the stock loses it’s value, your portfolio in turn loses it’s value. When you own five different assets and one loses it’s value, your portfolio still remains afloat on the remaining four. Some assets do better than others, but since you do not know which, you cannot exploit the fact in advance. Thus it makes sense to diversify; your portfolio will get the potential benefit of growing and the reduced risk of declining prices.

There is no magic number of assets to consider a portfolio diversified or safe. More stocks mean less price volatility. This means less risk, less reward. Diversification has no maximum, so long as there are assets to buy. There is also the overdiversification phenomenon, where a portfolio’s performance suffers because fees outweigh the gains of diversification.

Businesses can too employ diversification. Expanding the product line, acquiring related companies, integrating the supply chain, and forming conglomerate relationships and partnerships are just some of the ways they may do so.

Diversification even found it’s way into the Bible: “But divide your investments among many places, for you do not know what risks might lie ahead.” Diversifying has two implications: (1) the return can never exceed that of the top-performing investment; (2) the return can never drop below the worst-performing investment. So diversification makes you lose out on the best-performer’s gains and the worst-performer’s losses.

As a mental model, diversification extends beyond finance; it can aid decision-making in personal growth, business strategy, relationships, and daily routine.

Here are some practical applications:

• Financial: distribute your funds across stocks, bonds, real estate, and other asset classes;

• Career: build skills in multiple disciplines to remain versatile and competitive;

• Learning: try different learning vehicles—courses, webinars, videos, audiobooks—to broaden your understanding;

• Fitness: alternate between resistance training, stamina training, and flexibility training for holistic performance;

• Social: cultivate relationships across fields and diverse groups in order to expand your scope of opportunity—your network;

• Creative: attempt multiple mediums to broaden your creative output and fuel insight;

• Problem-solving: use various approaches—analytical, creative, intuitive, framework-centered—for better outcomes;

• Team: build diverse teams to incorporate different experiences and viewpoints.

The point of diversification is to lower your exposure to any given point of failure. To utilize the mental model, you may: (1) assess where you are relying on a single resource or strategy; (2) explore alternatives that could supplement or replace your method; (3) distribute your time, energy, and effort across multiple disciplines; (4) avoid overdiversifying to the point of dilution. As the proverb says, “Don’t spread yourself too thin.”

A few thought-provoking insights. “Don’t put all your eggs in one basket.” This helps you counter risk. “The fox knows many things, but the hedhehog knows one big thing.” This warns against over-specialization. “Variety is the spice of life.” This encourages experiencing different things for richness, versatility, and adaptability. “Plant trees of different fruits; some will bear sweet fruit in every season.” This advocates spreading effort to encourage consistency.

Questions to reflect on:

1. What areas of work could benefit from incorporating multiple perspectives or alternative approaches?

2. How might spreading your focus across projects or investments help buffer against unexpected challenges?

3. How can a diverse approach foster innovation and creative breakthroughs?

4. What risks do you face by relying heavily on a single strategy, and how can you mitigate them?

5. How can a balance between specialization and diversification result in more sustainable long-term outcomes?

Quotes that encompass the concept:

1. "Don't put all your eggs in one basket." - A traditional proverb.

2. "Diversification is the safety net that turns volatility into opportunity." - Unknown author.

3. "Variety in thought and action is the true path to innovation." - Unknown author.

Example use cases:

1. Investing: building a portfolio that spans various asset classes (stocks, bonds, real estate) to minimize the risk of any single market downturn.

2. Business: expanding product lines or targeting different customer segments to reduce dependence on a single revenue stream.

3. Creative: diversifying topics or experimenting with different formats (for writing, this could be articles, books, blogs) to maintain creative energy and open yourself up to new audiences.

4. Skill development: pursuing a mix of technical, creative, and interpersonal training to develop a well-rounded skill set prepared for diverse challenges in business and life.