Some risks are unavoidable. Some can be eliminated through prudence and discipline. One type of risk, called unique risk, representing the potential volatility that one company’s fortunes may bring to a portfolio, can be reduced simply by diversifying – by holding many different securities.
The following chart, which first appeared in Burton Malkiel’s “A Random Walk down Wall Street” shows the reduction in price volatility as a portfolio grows in size from 1 stock to 50 stocks.
The chart also displays how having a totally separate asset category, in this case international stocks, reduces overall volatility even more.
We achieve unique risk reduction through sector diversification and strict limits on exposure to any one company. Occasionally we use exchange traded funds or mutual funds as tools for smaller accounts as well as means to obtain broad involvement in a specific sector.