1. The egg basket problem
"Don't put all your eggs in one basket." Most people know this saying. The question is how to apply it when you invest.
Suppose you invest your entire ETB 100,000 in a single Ethiopian bank stock. If that bank performs well, great — your wealth grows. But if the bank faces a scandal, a regulatory action, or a bad year, you could lose 30%, 50%, or more with nothing to offset it.
Now suppose instead you spread ETB 100,000 across a bank stock, a manufacturing company, a government bond, and a 91-day T-bill. When the bank struggles, the bond and T-bill continue paying. The manufacturing company may even do well. Your overall portfolio stays much steadier.
The insight
Diversification does not increase your average expected return. It reduces the volatility — the swings — around that return. You get the same destination, smoother road.
2. What diversification does (and does not do)
What it DOES
- Reduces company-specific risk
- Smooths out portfolio volatility
- Protects against a single bad event wiping you out
- Allows you to take more total investment risk safely
- Improves risk-adjusted return (Sharpe ratio)
What it DOES NOT do
- Eliminate market-wide (systematic) risk
- Guarantee profits
- Protect against inflation
- Remove the need to understand what you own
- Work if all your assets are correlated
3. Systematic vs unsystematic risk
Total portfolio risk has two components:
Systematic risk (market risk)
Risks affecting the entire economy — inflation, interest rate changes, political instability, a global recession. Cannot be diversified away. When Ethiopia's economy slows, almost all ETB assets will be affected.
Unsystematic risk (specific risk)
Risks unique to a specific company, sector, or asset class — a bank CEO arrested for fraud, a drought devastating agricultural firms, a new competitor disrupting a sector. CAN be diversified away by owning many unrelated assets. This is the "free lunch" — eliminating risk you are not paid to take.
4. Correlation — the key concept
Two assets are well diversified when they have low or negative correlation — they do not tend to rise and fall at the same time. Correlation ranges from -1 to +1:
| Correlation | Meaning | Diversification benefit |
|---|---|---|
| +1.0 | Move in perfect lockstep | None |
| +0.5 | Move somewhat together | Partial |
| 0 | No relationship | Good |
| −0.5 | Tend to move apart | Strong |
| −1.0 | Perfect opposite movement | Maximum (rare) |
In practice, perfect negative correlation is rare. Most real portfolios achieve meaningful diversification with correlations between 0 and 0.4 across asset classes.
5. How many assets do you need?
Research by Evans and Archer (1968) showed that most unsystematic risk is eliminated with around 20–30 randomly selected, uncorrelated stocks. Beyond 30, additional risk reduction is marginal.
Portfolio risk as assets increase
Portfolio risk (volatility) drops sharply with the first 15–20 assets, then flattens near the systematic risk floor.
For Ethiopian investors starting out with smaller amounts, the key is not the exact number — it is combining asset classes that behave differently (equities, bonds, T-bills) before adding more stocks within each class.
6. Building a diversified Ethiopian portfolio
Here is how a well-diversified portfolio might look for different investor profiles using instruments available on Kashup:
Conservative (capital preservation)
Balanced (growth + stability)
Growth (long-term wealth building)
* These are illustrative allocations, not investment advice. Your ideal allocation depends on your time horizon, income, and risk tolerance. Use Kashup's suitability questionnaire.
7. Common diversification mistakes
✗ Holding 10 bank stocks thinking you are diversified
✓ You are not. All Ethiopian banks correlate highly. Sector diversification matters as much as the number of holdings.
✗ Ignoring time horizon
✓ T-bills are great for money you need in 3 months. They are wrong for a 20-year retirement fund. Match each asset to its purpose.
✗ Over-diversifying into complexity you cannot monitor
✓ 20 well-chosen assets you understand beat 100 assets you ignore. Diversify enough to eliminate specific risk, not so much that you cannot manage the portfolio.
✗ Treating ETB savings and investments as one
✓ Keep an emergency fund (3–6 months of expenses) in liquid savings, separate from your investment portfolio. Never invest money you might need suddenly.
✗ Assuming past correlations hold forever
✓ During a crisis, correlations tend to rise — assets that behaved independently in normal times can fall together. Review allocations annually.
8. Quiz: test your understanding
5 questions · Select one answer per question, then submit.
01What does diversification primarily reduce?
02You hold 20 stocks in your portfolio. Adding a 21st stock from the same sector will:
03Which pair of assets is MOST likely to be truly diversified?
04What is the 'only free lunch' in investing?
05Correlation measures:
Build a diversified portfolio on Kashup
Access Ethiopian equities, T-bills, government bonds, and corporate bonds in one place. Kashup's suitability engine recommends an allocation based on your risk profile.