Prosperitrade ‘the importance of portfolio diversification.

What does diversification mean when investing?

The word ‘Diversification’ refers to a way of reducing or eliminating risk through allocation or spreading of investment funds through various industries and investment instruments like stock market, mutual funds and treasury bills etc. The aim of this is to maximize returns by investing in different areas which will bring in good results as opposed to investing in a single instrument which may lead to losses. Investment experts however, do believe that even though it does not guarantee against loss, it’s still a great way of reaching your financial goals.

The following are ways to diversify your portfolio.

Diversifying helps to reduce your investment risks.

• Investment options: By diversifying your portfolio, you will get great benefits and lesser loss than investing in stocks only. This involves having a mix of bonds, commodities and stocks. With this, you will get the highest return at lower risks.
• Company size: There are large cap, mid-cap and small cap companies. ‘Cap’ means the capitalization of the company – number of shares multiplied by the stock price.
• Location: It is preferable to own shares in the United States, Japan, Europe and emerging markets. You can take advantage of growth with diversification instead of being vulnerable to just one stock.
• Mutual funds: With mutual funds, you will be able to own multiple stocks chosen by a mutual fund manager. You can also invest in index funds or index ETFs.
• Lower risk or loss: If one of your investments performs badly, others could perform better over the same duration lowering your losses.
• Preserving capital: For those who are close to retirement, diversification can help you preserve your capital for your retirement.
• Generating returns: Diversification helps you get good returns from multiple investments as some investment may not perform as expected. Thus, reducing your reliance on one source of income.

A diversified portfolio means spreading risk by investing:

• Across multiple asset classes like: property, fixed interest, cash and international shares
• Within the same asset class like buying shares across different industries.
• Across different fund managers if you’re investing in managed funds.

Usually, some investment do perform better than others over a period of time due to the following factors:

• Current market conditions
• Interest rates
• Currency markets

An investor can manage risks and reduce volatility of an asset by diversification. Note that you can never eliminate risks no matter how much you diversify your holdings.

Risk associated with stocks can be reduced though general market conditions do affect every stock so it is important to diversify. Ensure to find a middle point between risk and return as it can help you achieve your financial goals.