Managing an investment portfolio is often an independent endeavor, and without the proper guidance, you can risk missing out on profitable opportunities. In worse cases, you may also risk losing your profits entirely. One of the most acclaimed methods of reducing overall risk is through diversification. For those who are currently managing a hefty investment portfolio, it is especially crucial that you embrace diversification; this method is considered to be one of the most effective ways to grow and maintain your wealth.
What Is Diversification?
Put simply, diversification entails investing in various kinds of assets to better combat the effects of market fluctuation. The reason this tactic works is because these assets must be carefully assessed and selected so that it is assured that the assets will not be susceptible to the same decreases. These assets are often found in different markets, but that does not mean all assets in a portfolio must be unique. You may invest in multiple different stocks or bonds, for example. The important thing is to know your stuff—or hire someone who does.
How Should You Diversify?
Saying that diversification reduces risk is a nice sentiment, but that can be difficult to process and accept without examples. If you manage a portfolio of stocks in a number of different chain restaurants, you will be vulnerable to loss if the restaurant industry at large experiences a decrease in patronage or an increase of heavy criticism and share prices drop. To avoid this risk, you might also choose to purchase shares of a few family-owned restaurants. However, these assets are not only the same class, they’re in the same industry. If you want to truly diversify your portfolio and reduce the risk of losing your money, you should invest in multiple industries and asset classes. Doing so will ensure that all your money is not held in the same asset and that your portfolio has a higher chance of performing well even if one of your assets fails.
Diversification is an effective way to organize your portfolio so that you can mitigate some of the risk inherently associated with investments. However, it is important to recognize that a diversified portfolio does not guarantee the prevention of loss. It is simply a productive means to reduce risk and increase your avenues for growth.