Module 5 · Diversification You Can See Core

Diversification is easy to claim and easy to fake. Twelve tickers can be three bets; an index fund plus its own largest holdings can be the same bet three times. A practice account is the ideal place to learn to see this, because you can audit it without any real money depending on the answer.

Holdings are not bets

Suppose a practice portfolio holds five Canadian banks, two pipeline companies and a Canadian index fund. That is eight holdings. It is closer to two or three bets: Canadian financials, Canadian energy infrastructure, and a fund that is itself heavily weighted to both. When the Canadian economy or interest rates surprise, most of the portfolio moves together.

The question that matters is not “how many things do I own?” but “how many different things would have to go wrong for this portfolio to have a very bad year?” If the honest answer is “one”, the portfolio is concentrated, however long the positions list is.

Weights, not counts

Every audit starts with weights:

Weights also drift. A stock that rises while the rest of the account is flat grows its weight without you doing anything. A position bought at 4% can be 8% a year later — which is good news, and also a concentration you never chose.

The overlap hiding in your funds

Index funds are weighted by company size, so the biggest companies dominate them. In recent years the ten largest companies in the S&P 500 have made up more than a third of the index. Own an S&P 500 fund, a Nasdaq-100 fund and a few of the same mega-cap technology stocks individually, and you hold the same handful of companies three times over.

To see your true exposure, “look through” each fund: take its top holdings from the fund provider’s website, multiply each one’s weight in the fund by the fund’s weight in your account, and add it to anything you hold directly.

Correlation, and what happens in a crash

Correlation measures how consistently two investments move in the same direction, from +1 (always together) to −1 (always opposite). Companies in the same industry tend to be highly correlated because the same forces — commodity prices, interest rates, regulation — hit them all at once.

The uncomfortable part is that correlations between ordinary stocks tend to rise in a sell-off. In the autumn of 2008 and in March 2020, almost everything fell together. Diversification across stocks still helps — it protects you from any one company failing — but it does much less to protect you from the market as a whole. That is the job of cash, of bonds, and of position sizes you can live with.

You can see correlation directly: put two of your holdings into Compare and look at whether their charts rise and fall on the same days.

A one-page concentration audit

Build this table for your practice account. It takes about fifteen minutes and is the same exercise worth doing on a real portfolio once a year.

Then answer four questions in your notes:

• Is any single stock above the limit in your plan, once look-through exposure is included?
• Is any sector above your cap?
• What share of the account is in one country? (For many Canadians the answer is surprisingly high, or surprisingly low.)
• If your largest sector fell 40%, how much would the whole account lose? (Sector weight × 40%.)

Practice in Paper Trading