Diversification

Diversification is the mechanical consequence of combining assets whose returns are imperfectly correlated: the portfolio's aggregate volatility is lower than the weighted average of its parts. That's the only "free lunch" in portfolio theory — and it only works to the degree the correlations are genuinely below 1.

Two kinds of risk move differently in response to diversification. Idiosyncratic risk — the part of a return that's specific to one company or sector — shrinks toward zero as positions are added. Systematic risk — the part tied to the broader market's movements — doesn't shrink, because the diversifying positions share it.

A portfolio can look diversified by count (many holdings) but behave concentrated (all correlated to one sector, region, or factor). Counting positions is necessary but not sufficient.