Diversification and portfolio construction

Managing risk with diversification

This also works in reverse.

If the HIH Insurance share doubled in value, Portfolio One would have doubled in value.

However Portfolio Two would have risen by only 1% (again, assuming the other 99 shares did not change in value).

So by investing in one share rather than 100 shares you are increasing the risk of your portfolio because you are reliant of the performance of just one company whereas with Portfolio Two, your investment outcome is based on the performance of 100 companies. Accordingly the return on the one-share portfolio could be radically different from the 100-share portfolio.

You could still have a lack of diversity with a portfolio of 100 shares. You could have 100 shares in one sector (for example, banks or transport) and therefore even though you have 100 shares, your diversity is still limited.

To increase the diversity of this portfolio you would need to diversify amongst other sectors and even other countries.