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Diversification simply put, is just putting your investment in multiple stocks, assets, sectors that have no similar value added relationship to help you reduce risk of losing investment money.

 

A diversified investment is a portfolio investment in multiple stocks, assets or sectors that have no correlation with one another that help you reduce the risk of losses.

 

Have you come across the quote “Don’t put all of your eggs in one Basket”, pretty familiar right? It is apt to your role as an investor who wants to mitigate loses.

 

For example, Mr David, as an investor, wants to diversify his investments. So rather than invest only in tech/communications, in order to reduce the chances of losing, he diversifies and invests in oil firms’ stocks, government bonds, and banks stocks, not still confident of his investment, he goes into commodities, agriculture and other areas of business to invest till he feels he’s running with minimal risk of losing all his investments.

 

You see Mr David having channelled his investment on different sectors is safer because if there’s a crisis in the tech world and all the tech industry crashes, he’s got investment in oil, government, banks and way down to agriculture.

 

The key priority of diversification is reducing risk of loss.

 

Diversification can't protect investors entirely from risk. Sometimes, financial markets lose value at the same time, and nearly every stock, bond, or fund loses value. More often, though, a diversified portfolio will cushion the blow of a downturn and help you avoid the full consequences of making an unfortunate stock selection.

 

There's also little chance that the entire portfolio will be wiped out by any single event. That's why a diversified portfolio is your best defence against a financial crisis.

 

Although, diversification can help an investor manage risk and reduce the volatility of an asset's price movements. Remember, however, that no matter how diversified your portfolio is, risk can never be eliminated completely.

 

It is never a bad idea to keep a portion of your invested assets in cash or short-term money-market securities in case of an emergency because short-term money-market securities can be liquidated instantly.

 

In general, the more risk you are willing to take, the greater the potential return on your investment, remember, the higher the risk, the higher the returns and vice versa.

 

Investors will usually go for bonds and stocks creating different assets allocation portfolio. Usually, an aggressive investor would go for 80% stock and 20% bonds while the conservative investors go for 20% stock, 80% bonds.

 

With stocks, investors can choose a specific style, such as focusing on large, mid or small capitalization.

 

Bonds also offer opportunities for diversification. Investors can choose long-term or short-term issues. They can also select high-yield or municipal bonds.

 

While stocks and bonds represent the traditional tools for portfolio construction, a host of alternative investments provide the opportunity for further diversification. These include Real estate investment trusts, hedge funds, Fixed Deposit, Commodities, and Treasury Bills etc.

 

Regardless of your intention, there is no generic diversification model that will meet the needs of every investor.

 

Your personal time horizon, risk tolerance, investment goals, financial means and level of investment experience will play a large role in dictating your investment mix.

 

You can build your own diversified portfolio by combining numbers of individual stocks, bonds, or other investments. In general, buying stocks that differ in size, industry, geography, and corporate strategy can give you more of the benefits of diversification. Focusing on similar stocks in the same sector adds minimal diversification to a portfolio.

 

Start by figuring out the mix of stocks, bonds and cash that will be required to meet your needs. From there, determine exactly which investments to use in completing the mix, substituting traditional assets for alternatives as needed.

 

However, if you are too overwhelmed by the choices or simply prefer to delegate, there are plenty financial services professionals available to assist you, usually, at a fee.

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