Why Portfolio Diversification Matters

Why Portfolio Diversification Matters?

You probably have heard about the saying “do not put all of your eggs in one basket” because if you do, you would not have anything left when the basket falls. The concept of portfolio diversification has been a long topic in the field of financial investing. By now, you may already know the basic meaning of diversification and it is making a wise distribution of your investments over the different sectors of the market.

In this article, you are going to learn the utmost importance of portfolio diversification and why you should do it immediately.

 Investment Eggs in a Basket

Diversify to Soften Drawbacks

As you diversify your portfolio, you lessen your market risk especially when a particular sector is under-performing.  Asset allocation is a wise way to adapt to a changing market environment.

Since nobody can precisely predict the outcome of the market, portfolio diversification can be of help a lot to the investors and be able to survive even the most harsh market conditions. When the inevitable happens, your other investments can offset the losses.

Diversify to Maximize Returns

Aside from protecting the health of your portfolio, diversification also gives you the opportunity to maximize returns by investing in different areas that would have a different reaction to the current situation of the market. By allocating your investments among several different financial instruments, businesses and even categories, you are somewhat guaranteed against losses.

Diversify to Target Across the Board

This setup can be regarded as superior portfolio diversification. That is, diversifying your portfolio across the board. Normally, when investors diversify, they do it with several companies. But when you do across the board diversification, you target different types of industries.

The more your stocks become unconnected or unrelated with each other, the better and more advantageous it is for your portfolio.

Another across the board technique is diversifying among different asset classes (i.e. bonds and stocks, equity markets, etc.). When adverse events happen, such types of assets would react differently since you have a combination of asset classes. Just like what is expected, unpleasant movements in one class will be counterbalanced by the upbeat results from the others.

Diversify to Own More than Owning Just One

Another obvious reason why you should diversify is because it is better to own more stocks than just having one. Market experts suggest that optimal diversification is achieved when an investor owns at least 15 to 20 stocks expanded across several industries.

However, it is still important to apply proper risk tolerance to determine the right assortment of your own choice of assets.

Conclusion

Generally, market downturns and risks affect nearly every stock.  Diversification may not completely protect your portfolio from risks or even guarantee elimination of chances of a loss, but it can help an investor manage the risks and reduce the impact of market volatility.

 

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