Ever heard the saying “putting all your eggs in one basket”? It is essentially a warning that you should not concentrate all efforts and resources in one area as one could lose everything.
This applies to shares/stocks. So to overcome this we diversify. In other words, we don’t just buy shares in one company, instead, we buy shares in multiple companies.
An example of “putting all your eggs in one basket” is using all your savings to buy 10 Google shares 1 year ago which would have cost you $1,449. Today they would be worth $950 (-34%).
However, if we had split our investment equally between Google and Conoco Phillips we would have bought 9 x Conoco Phillips ($720 @ $80 each) and 5 x Google ($725 @ $95 each). We would have still lost 34% on Google but we would have made 55% on Conoco Phillips. Increasing the value of our portfolio from $1,445 to $1,591 (+10%). This is diversification – you win some, you lose some – you just hope to win more times than you lose.
So how many companies/shares would be a well-diversified portfolio? While there is no magic number, it is typically advised that it would be between 20 and 30 shares/companies (as a minimum). Ideally from different sectors. A longer explanation can be found here.
Is there an easier way? Yes, one way is buying an exchange-traded fund (ETF) instead of single shares. ETFs are already diversified investments. They come in many different flavours, some are very broad while some are very sector focused. To get started, have a look at Vanguard.