Dear Young Investor,

I want to take you back to the early 1970s, when there was a group of 50 specific stocks that everyone loved in the US. They were called the “Nifty Fifty.”

These weren’t obscure penny stocks, but titans of American industry companies like Kodak, Polaroid, and Xerox. The narrative on the street was that these were “one-decision” stocks. You only had to make the decision to buy them. You never had to sell. You never had to worry. They were considered so dominant and safe that price didn’t matter.

Investors poured their life savings into this basket, believing nothing could go wrong.

Then, the 1973 bear market arrived.

The illusion of safety shattered, and these “invincible” giants were decimated. Kodak lost half its value. Polaroid eventually collapsed by 90%.

It was a brutal reminder of a fundamental law in economics that usually holds true for physics and even dieting. It’s that there is no such thing as a “free lunch.”

The universe is transactional and ruthlessly demands a payment for everything it gives you. If you want higher returns, which also come with the high probability of higher losses, you must generally accept stomach-churning risk. And if you want safety, you have to accept a yield so low it barely covers inflation.

However, while I won’t bore you with the academic theories, many of which are frankly broken because they assume markets are rational, there is still one free lunch in the game of wealth creation.

Barry Ritholtz explained it best:

I prefer to think of diversification as “survival insurance.”

It is the only time in your investing life where you can reduce the chance of a catastrophic outcome without necessarily sacrificing your ability to build wealth over decades.

Now, I know what you’re thinking. Most investors who read Charlie Munger or Warren Buffett believe what they say about diversification, that it is “protection against ignorance” and that it makes no sense if you know what you are doing.

We love quoting Buffett on concentration because it validates our greed, but we conveniently forget that Buffett also says most people should just buy an index fund and go play golf.

But you have to ask yourself, with complete honesty: Are you Warren Buffett? Do you have a 60-year track record, a direct line to management, and the stomach to watch your net worth get cut in half without panicking?

For the rest of us mortals, the future is a black box, not a spreadsheet. We diversify not to hit some perfect mathematical sweet spot, but simply because we respect the fact that the world is chaotic, messy, and prone to “black swan” events that no model can predict.

The legendary financial historian Peter Bernstein put it best when he told Jason Zweig:

Let me talk a bit about your portfolio, because I know what it probably looks like right now. You might be holding five different mutual funds and feeling very responsible about it, thinking you are spread out and safe. But if you look deeper and see the portfolio overlap, you’ll likely find that all five funds are heavily invested in the same usual suspects: HDFC Bank, Reliance, ICICI, and Infosys. Whether you have a flexi-cap fund, an ESG fund, or even a contra fund, most of the top holdings are nearly identical.

It’s like eating a Thali where every single bowl - the dal, the sabzi, and the curry is just made of potatoes. If the potatoes turn out to be rotten, or if you find out you’re allergic to potatoes, your entire meal is ruined.

Real diversification means owning things that have nothing to do with each other. It means having your “potato” equity funds, but also perhaps a little gold that acts like the cooling curd when the spices get too hot, and a boring debt fund that acts as the rice base.

In the Indian market, which can be incredibly volatile and often driven by fancy stories, sectors can vanish for years at a time. Look at how Infrastructure was the darling in 2007 and then destroyed wealth for a decade, or how IT goes through cycles of euphoria and despair. If you are 100% concentrated in the “hot” sector of the moment, you are betting that the music will never stop.

But history tells us the music always stops eventually. And it’s like a game of musical chairs at a birthday party, but in the markets, when the music stops, they sometimes take away the whole floor instead of just taking away a chair.

By diversifying, you are admitting that you don’t know which sector, stocks, or funds will win next year, but you are confident that the Indian economy as a whole will grow.

Now, the price you pay for this free lunch is psychological rather than financial. You will always hate part of your portfolio. If the Nifty Smallcap index is surging 50% in a year, your gold and large-cap funds will look like dead weight, and you will feel a pang of jealousy looking at your friends who went “all in” on the winners. You will feel stupid.

But in the long run, the concentrated investor is often wiped out by a single bad decision or an unforeseen regulation change, while the diversified investor keeps compounding.

Before I end, I want to leave you with a practical guide on how to practice diversification without taking it too far.

You do not need to own 50 different stocks or 10 different mutual funds. That is what Peter Lynch called “diworsification.” At that point, instead of reducing risk, you are just increasing complexity and fees.

The sweet spot usually lies in simplicity:

- Mutual Funds: Three or four funds are usually enough. One for large stable companies, one for mid/small growth companies, and one for international exposure or a different asset class like debt (like a balanced advantage fund).

• Stocks: 10 to 15 names across different industries is plenty. Any more than that, and you won’t be able to keep track of them.

Ultimately, the best measure of adequate diversification is the “Sleep Test.”

If you can go to bed at night without checking the US markets to see if your India portfolio will crash by morning, you are diversified enough. If you are constantly anxious, you are too concentrated. And if you are bored? Well, then you are probably doing it exactly right.

Remember that you don’t diversify to get rich overnight; you diversify so that you can survive long enough to get wealthy eventually.

Yours,
Vishal