What is diversification, in simple terms?

Diversification is the "don’t put all your eggs in one basket" idea applied to money. If you own one company and it fails, you lose everything. If you own fifty and one fails, you lose 2 percent and probably do not notice. Spreading your money across many investments trades away the chance of a spectacular win on one for protection against a wipeout.

The trick is that the baskets have to be genuinely different. Owning ten technology companies is one basket; when the sector falls, they all fall. Real diversification means different industries, different company sizes, sometimes different countries, and often some bonds, which tend to hold up when stocks fall.

What it does not do is prevent losses in a bad year. When the whole market drops 25 percent, a diversified stock portfolio drops something like 25 percent too. Diversification protects you from any one thing going wrong, not from everything going wrong at once. Bonds and cash are the tools for that.

The cheapest way to get it: a single total-market index fund holds thousands of companies across every sector, and a total-bond fund alongside it covers the rest. Two purchases, diversified.