Money 101 · Module 6 of 6: Risk · Lesson 1 of 3 · 4 min read
Risk and diversification
Every investment can lose value, so risk is not something you can remove – only something you can understand and manage. Diversification, or spreading your money, is the simplest way to stop one bad outcome from doing too much damage.
What risk means here
Investment risk is the chance that the result is different from what you hoped, including losing money. Prices can swing up and down, a company can fail, and you might need to sell at a bad moment.
Investments that can rise a lot can usually also fall a lot. No investment offers high returns with no risk, so treat any promise of that as a warning sign.
A worked example of spreading
Say you have €10,000 to invest and one company's shares fall by half.
All in that one company: you lose €10,000 × 50% = €5,000, which is half of your money.
Split across 20 holdings of €500 each: you lose €500 × 50% = €250 on the one that fell, which is €250 ÷ €10,000 = 2.5% of your money.
Ways to spread your money
Diversification works best when your holdings do not all react to the same news. You can spread across:
Many companies instead of a few
Different industries, such as energy, health and technology
Different countries and regions
Different types of assets, such as shares, bonds and cash savings
Time, by investing a fixed amount regularly instead of all at once
What diversification can't do
Spreading reduces the damage from one company or one sector going wrong. It does not protect you when the whole market falls together. In the example above, if all 20 holdings fell 30% at the same time, you would lose €10,000 × 30% = €3,000 however you had split the money.
Owning many funds that hold the same companies is also not real spreading. Check what the funds actually hold. A single fund that holds many companies, like an ETF, can already give wide spread – see what is an ETF?
Match the risk to the time you have
Money you may need within a few years has less time to recover from a fall. That is why an emergency fund belongs in savings, not in shares – see why an emergency fund.
Money you will not touch for many years can ride out more ups and downs, but it can still lose value. Decide in advance how big a fall you could live with without selling in a panic.
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Key takeaways
Every investment can lose value; risk can be managed but not removed.
Spreading €10,000 across 20 holdings turned a €5,000 loss into a €250 loss in the example.
Diversification does not protect you when the whole market falls together.
Try it
Start with the €10,000 from the example. The 5% return is only an assumption – try lower and higher rates to see how wide the range of outcomes can be.
3 questions. Pick an answer to see why it's right or wrong.
You split €10,000 across 20 holdings of €500 each. One falls by half. How much do you lose?
Not quite. That would mean the holding fell to zero.
Right. €500 × 50% = €250, which is 2.5% of €10,000.
Not quite. That is the loss if all €10,000 was in that one company.
Show the answer
€250 – Split across 20 holdings of €500 each: you lose €500 × 50% = €250 on the one that fell, which is €250 ÷ €10,000 = 2.5% of your money.
What does diversification not protect you from?
Not quite. Spreading across sectors limits this damage.
Right. If everything falls at once, spreading does not prevent the loss.
Not quite. This is exactly the risk spreading reduces.
Show the answer
The whole market falling together – It does not protect you when the whole market falls together.
Why does an emergency fund belong in savings rather than shares?
Not quite. Shares can rise or fall; the issue is timing.
Right. You may have to sell at a bad moment if you need the money quickly.
Not quite. The lesson does not compare returns; it is about time to recover.
Show the answer
Because money you may need soon has less time to recover from a fall – Money you may need within a few years has less time to recover from a fall.
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Education, not advice. I'm not a financial adviser and I don't know your situation. These tools show the maths behind common rules of thumb; check important decisions with a qualified professional. Full disclaimer.
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