Module 10 · Investing
Diversification and the main asset classes
Why spreading money across many investments removes a risk you are not paid for, how correlation works, and what cash, bonds, shares, property, gold and crypto each do.
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In this lesson
- Explain diversification and why one company is much riskier than a broad mix
- Describe correlation and why low-correlation assets smooth the ride
- Compare the main asset classes by income, risk and long-run behaviour
- Explain home bias and why asset allocation drives most of a portfolio's risk
Petra, 45, owns €40,000 of shares in the company she works for. A rumour says the firm may cut jobs. If it does, she could lose her salary and a large part of her savings in the same month. What would have made her safer?
One company is a risk you are not paid for
means spreading money across many investments so that no single one can do great damage. If you own one company and it fails, you lose 100%. If you own equal slices of 500 companies and one fails, you lose 0.2% while the other 499 keep working.
Single shares are risky for another reason. A well-known study of US shares from 1926 to 2016 found that the best-performing 4% or so of companies explained the market’s entire gain over cash, and most individual shares earned less over their lifetime than short-term government bills. If you hold the whole market, you are sure to own the rare big winners.
Correlation: who falls when
measures how closely two investments move together, from +1 (always together) to −1 (always opposite). Diversification works best with investments that are not tightly linked.
The main asset classes
An is a group of investments that behave in similar ways.
| Asset class | What it is | Long-run behaviour |
|---|---|---|
| Cash and money-market funds | Bank balances, very short-term loans | Very stable; about 0.5% a year after inflation (US, 1900–2025) |
| Bonds | Loans to governments and companies | About 1.6% a year after inflation; can lose when interest rates jump |
| Shares | Part-ownership of companies | About 6.6% a year after inflation; deep falls along the way |
| Property | Homes, offices, listed property companies | Rent plus price changes; costly and hard to sell quickly |
| Gold and commodities | Raw materials | No income; gold’s real price rose about 5 times since 1900, much less than shares |
| Crypto | Digital tokens | Under 20 years of history, very large swings; see the last lesson |
A useful split is between assets that produce cash flows (shares pay dividends, bonds pay interest, property pays rent) and those that only gain if someone later pays more (gold, most crypto).
Allocation and home bias
How you divide money between asset classes is your , and it drives most of a portfolio’s risk. Since 1900, shares and bonds have each lost more than 70% in real terms at times, yet a 60/40 mix of the two never fell more than 50%.
People also tend to buy mostly their own country’s shares. This is home bias.
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