Compute the same example with 50% weight for each company.
An index can weight companies by market cap, price or equal weight. A large number of companies does not guarantee balanced diversification.
In a market-cap-weighted index, larger companies can have greater influence; sometimes only freely tradable shares are used and weight caps apply. In an equal-weight index, company weights are equal at rebalancing dates and then change with prices. An index is a measurement tool; to get exposure you can use a tracking product, whose results may deviate due to costs and tracking error.
In a fictional basket, Company A at 80% weight rises 10% and Company B at 20% weight falls 10%. Assuming initial fixed weights and no costs, the basket change is 0.8×10% − 0.2×10% = 6%.
Compute the same example with 50% weight for each company.
An imaginary index contains two companies with weights of 80% and 20%. If the first rises 5% and the second falls 5%, the index gains approximately 3%: the first contributes four percentage points and the second subtracts one. The simple average of their returns would be zero, which is a different calculation. An index increase therefore does not mean every member rose. Read the weighting method and check how strongly the largest constituents influence it.
Concepts that help you compare
How does one fund unit represent a basket of stocks?
A unit in a fund gives a proportional share of a fund that holds assets; it is not one share in each company. The fund pools money and holds a basket according to its policy. One unit gives proportional exposure to the basket, even if each company's weight differs. The number of units you own is not the number of companies in the fund. The basket can include stocks, bonds or other assets. A fund can track an index or be actively managed. Read the investment policy and holdings—not just the name.
Comparison example: A fictional fund holds 60% in Company A and 40% in Company B. A holding valued at 100 ₪ in the fund roughly represents exposure of 60 and 40 ₪, before cash, costs and pricing differences.
Diversification is splitting investments among different assets and sectors. This reduces dependence on a single asset. Three companies in the same sector may behave similarly, so the number of holdings alone does not guarantee good diversification. A diversified portfolio can still fall when the market declines.
Comparison example: Three game companies depend on some of the same factors. Combining different sectors changes exposures.