Why do Financial Experts say, ‘Don’t Put All Your Eggs in One Basket’?
by Chris Brown, Ph.D., MBA, CFP® and Ron A. Rhoades, JD, CFP®
This is Part 2 of Scholar Financial’s “Evidence-Based Investing” series. To view the entire series, click here. To receive bi-weekly updates on the rest of this series, please join our email newsletter by clicking here.
Robert had done everything right – or so he thought. During 32 years as a manufacturing supervisor, he diligently saved for retirement. He believed his strategy – investing heavily in his company’s stock – was bulletproof. After all, he knew the business inside and out. He watched it grow. He trusted it.
Then, eighteen months before his planned retirement, the unthinkable happened. New international competition emerged, the stock plummeted, and Robert watched helplessly as 60% of his retirement savings vanished in a single year. The “sure thing” had become a nightmare.
Robert’s story is heartbreaking – but not unusual. It illustrates one of the most important principles in investing, which Nobel Prize-winning research has proven beyond doubt: diversification isn’t just advice. It’s science.
The Mathematics of Not Losing Everything
In 1952, economist Harry Markowitz published “Portfolio Selection” – and changed investing forever.(1) His insight was elegant yet profound: the risk of a portfolio depends not just on the riskiness of its individual investments, but on how those investments move in relation to each other.
In other words, if you hold investments that don’t always move in the same direction, your overall portfolio becomes less volatile than its individual components. When some assets lose value, others may gain, cushioning the blow to your total wealth.
This wasn’t just theory. Markowitz proved it mathematically, and his work earned him the Nobel Prize in Economics in 1990.(2) Modern Portfolio Theory (MPT), as it came to be known, revolutionized how professional investors think about building portfolios.
Two Types of Risk—Only One You Can Eliminate
Modern Portfolio Theory teaches us that investments carry two distinct types of risk. The first is systematic risk – market-wide risk that affects all investments. Think of major recessions, interest rate changes, or global economic crises. You cannot eliminate this risk through diversification among just stocks; it’s the price of admission to the stock market.
The second type is idiosyncratic risk – company-specific risk. This is what happened to Robert. His company faced industry-specific challenges that devastated his concentrated portfolio. Here’s the crucial insight: this type of risk can be significantly reduced through diversification.
When you hold a single stock, you’re exposed to everything that might go wrong with that one company – management failures, competitive disruptions, regulatory changes, or simple bad luck. When you hold hundreds or thousands of stocks across different industries and geographies, individual company problems become mere ripples in a much larger pond.
The Efficient Frontier: Your Portfolio’s Sweet Spot
Markowitz introduced another powerful concept: the Efficient Frontier.(3) This represents the set of portfolios that offer the maximum expected return for any given level of risk (as measured by the standard deviation of the historical returns of the portfolios). Portfolios on this frontier are considered optimal – there is no way to get more return without accepting more risk, and no way to reduce risk without sacrificing some return. While refinements to the application of Markowitz’s theories have necessarily occurred, in order to permit broader diversification among asset classes (thereby seeking to reduce another form of risk) and to take into account valuation levels of those asset classes (which influences expected returns over the long term), the core principles leading to portfolios close to or on the Efficient Frontier still remain relevant today.
For practical investors, this means there exists a mix of asset classes, and usually broad diversification within each asset class, reflecting your specific situation. The goal is not to find the highest-returning investments regardless of risk, nor to eliminate all risk regardless of return. Rather, the goal is to identify the portfolio that will likely deliver a high level of expected future returns for the level of risk you can comfortably accept, as well as the level of risk designed to assist you in obtaining your lifetime financial goals.
Why Prediction is Futile
John Bogle, the legendary founder of Vanguard, spent his career championing diversification for a simple reason: it is impossible to predict which individual stocks or sectors will outperform each year.(4) Markets are humbling. The top-performing sector one year often becomes the laggard the next.
But here is the good news: by investing in a diversified portfolio of carefully selected asset classes, and then diversifying further within each asset class, you participate in the overall growth of the market over time. You don’t need to predict winners. You just need to own enough of the selected asset classes that you will hold the winners within those asset classes – wherever they happen to emerge.
This is why low-cost mutual funds and exchange-traded funds have become so popular. A single fund can provide exposure to hundreds or thousands of stocks, offering instant diversification that would be impossible for individual investors to achieve on their own.
The Lesson Robert Learned
Robert eventually recovered, though it took longer than he had hoped. With what remained of his savings, he built a properly diversified portfolio. He spread his investments across U.S. stocks, international stocks, and bonds. Within those categories, he diversified across investment styles using techniques such as factor-based investing.(5)
“I thought I was being smart by investing in what I knew,” Robert reflected. “But I was actually taking on massive, unnecessary risk. The research was there all along – I just didn’t know to look for it.”
The phrase “don’t put all your eggs in one basket” has been around for centuries.(6) But thanks to Modern Portfolio Theory, we now understand exactly why this wisdom works for investing – and we can quantify how much risk (as measured by volatility) we are reducing when we diversify properly.
For investors approaching retirement, the stakes couldn’t be higher. There’s no time to recover from a Robert-style disaster. But with proper diversification – the kind backed by Nobel Prize-winning research – you can pursue growth while protecting yourself from the catastrophic risk of concentration.
The eggs-in-one-basket advice isn’t just folk wisdom anymore. It’s evidence-based investing.
About the Authors
Ron A. Rhoades, JD, CFP®
Ron Rhoades is an Associate Professor of Finance at the Gordon Ford College of Business, Western Kentucky University. He also serves as a financial advisor at Scholar Financial, a practice within XY Investment Solutions LLC. With a background as both an attorney and a CERTIFIED FINANCIAL PLANNER™ professional, Ron is a nationally recognized authority on the fiduciary duties of financial advisors.
Chris Brown, Ph.D., CFP®
Chris Brown is a faculty member in the Department of Finance at the Gordon Ford College of Business, Western Kentucky University, and a financial advisor at Scholar Financial, a practice within XY Investment Solutions, LLC. He holds the CERTIFIED FINANCIAL PLANNER™ designation and a Ph.D. in Personal Financial Planning. His research and teaching focus is on behavioral finance, retirement planning, and evidence-based investment strategies.
Endnotes
1. Markowitz, Harry. “Portfolio Selection.” The Journal of Finance Vol 7, No. 1 (March 1952), 77-91. https://www.math.hkust.edu.hk/~maykwok/courses/ma362/07F/markowitz_JF.pdf
2. Harry Markowitz was awarded the Nobel Memorial Prize in Economic Sciences in 1990, along with Merton Miller and William Sharpe, for their work on the theory of financial economics. Nobel Prize. (1990). The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 1990.
3. Corporate Finance Institute Team. “Efficient Frontier.” https://corporatefinanceinstitute.com/resources/career-map/sell-side/capital-markets/efficient-frontier/
4. Bogle, J. C. (2017). The Little Book of Common Sense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns. John Wiley & Sons.
5. See Fidelity’s explanation of Factor-Based Investing: https://www.investopedia.com/terms/f/factor-investing.asp
6. The phrase was first used in the 1605 novel Don Quixote, where it was written “It is the part of a wise man to keep himself today for tomorrow, and not venture all his eggs in one basket.”
This article is for educational purposes only. It should not be construed as financial, legal, tax, or investment advice, nor as a recommendation to implement any specific strategy, product, or investment. Consult with a qualified financial professional before making investment decisions.
