Diversification is an important investment strategy that helps investors reduce overall portfolio risk. It does so by allocating investments across various asset classes that have low correlation.  The aim of diversification is simple,  minimise risk while maximising returns.

The Importance of Diversification

Let’s say your portfolio only contains Food and Beverages (F&B) stocks. It is then made known to the public that all livestock is contaminated due to certain farming practices.  The share prices of your F&B stocks will definitely drop in value, and your portfolio is inadvertently affect.  If you were well-diversified, you would have protected yourself from such unsystematic risks.

The lower the correlation between investments, the better it is. Unsystematic risks will only affect specific targeted industries and companies. It is important to diversify among different asset classes. They usually perform differently in adverse situations.

While many agree that diversification is no guarantee against market swings and systematic risks, it is still an important strategy to adopt to achieve your goals and objectives.  This spreading of wealth to many unrelated financial products helps to reduce volatility and unsystematic risks that may affect your portfolio negatively.

Read Also: Why This Nobel Prize-Winning Theory May Be Hurting Your Investment Portfolio

Over Diversification

 

 

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