What is Diversification?
We’ve all heard the old adage “Don’t put your all your eggs in one basket!”
In essence that is what Asset Diversification of your investment portfolio is.
Diversification on is a common investing technique used to reduce your chances of experiencing large
losses. By spreading your investments across different assets, you are spreading the risk and you are
less likely to have your portfolio wiped out due to one negative event impacting that single company
or asset class. Instead, your portfolio is spread across different types of assets such as property, fixed
income and company shares, preserving your capital.
How does Diversificationon work in practice?
A diversified investment portfolio includes different asset classes such as stocks, bonds, and other
securities. But that’s not all. These vehicles are diversified by purchasing shares in different
companies, asset classes, and industries. For instance, a diversified investor’s portfolio may include
the stocks of retail, technology, and consumer-staple companies, as well as bonds—both corporate and
government-issued. Further diversification may include money market accounts, alternative
investments, and cash.
An example of why Asset Diversificationon is important.
Traditionally investing in bank shares was seen as solid investment providing capital growth and a
steady income from dividends. However, the Financial Crises of 2007 to 2008 changed that
perception with the value of some bank shares falling by as much as 90% or more.
If you had only invested in bank shares your portfolio would have reflected this fall in value. However,
if you had invested in a fund with holdings in 20 to 30 companies across different sectors you would
not have been as exposed to the collapse in bank shares nor suffered the same level of loses.
What Happens When You Diversify Your Investments?
As you can see from the example above, when you diversify your investments, you reduce the
amount of risk you’re exposed to in order to maximize your returns. Although there are certain risks
you can’t avoid, such as systematic risks, you can hedge against unsystematic risks like business or
The Bottom Line
Diversification on can help an individual investor manage risk and reduce the volatility of an asset’s price
movements. Remember, however, that no ma;er how diversified your portfolio is, risk can never be