Pros of Diversification

What is Diversification?

Diversification is a method of risk management where risk is reduced by distributing funds over multiple financial instruments, industries, or some other categories for investments. A diversified investment portfolio can be created by combining different assets and instruments to control the risk exposure of any single individual investment asset. The prime objective of diversification is to maximize returns and minimize risk by investing in multiple sectors that would reap higher and long-term returns. Financial experts mention that diversification doesn’t guarantee protection against any financial loss, but it is considered to be the most efficient and effective technique to obtain long-term financial goals by minimizing risk....

How does Diversification Work?

1. Risk Reduction: A diversified portfolio comprises various investments that can reduce the risk associated with individual investments. As per studies and mathematical models, an optimum amount (25-30 stocks) of investments can contribute to the most effective level of risk reduction. Different investments react differently to market conditions, economic events, and other external factors, reducing the overall risk of the portfolio....

Strategies of Diversification

Diversification can be carried out using multiple strategies. In the financial world, investors try multiple strategies to diversify their portfolios so that with minimum risk, they can earn potential profits. The strategies can be amalgamated to improve the diversification level within a single portfolio....

Diversification Across Platforms

Diversification across platforms in the finance sector refers to spreading investments or financial activities across different types of financial services or platforms. From traditional banking to online banking and cryptocurrency, diversification of investments can be carried out. Different investment platforms such as robo-advisors, brokerage firms (both online and offline), and investment apps can be apt in diversifying your portfolio. Some of the other platforms include peer-to-peer lending, real estate crowdfunding, insurance platforms, and fintech services that investors can use to diversify their portfolios. Different platforms have different return-risk profiles and investors are keen to explore these strategies....

Importance of Diversification

1. Reducing Risk and Preparing a Stable Portfolio: Spreading your investments into multiple assets or instruments helps in minimizing the impact of uncertainties or risks associated with individual investments. This helps in building a more stable and smoother portfolio by offsetting the losses in one sector with profits in another sector. The overall performance of the portfolio is enhanced....

Diversification and Retail Investors

Retail investors or individual investors might find it difficult to manage a properly diversified portfolio due to time and budget constraints. This is why, mutual funds are a common form of investment among retail investors. Mutual funds are a convenient and less expensive way to diversify their funds....

Pros of Diversification

1. Diversification reduces the risk associated with an individual asset instrument or industry by offsetting the poor performance of one sector with the good performance of another sector....

Cons of Diversification

1. Sometimes, over-diversification can lead to diluted returns as a higher benefit of one can be neutralized by another higher-risk asset....

Difference between Diversifiable Risk and Non-Diversifiable Risk

The main purpose of diversification is to reduce or rather eliminate risk from the investment portfolio. However, the risk associated with individual assets or financial instruments can be of two types: systematic risk and unsystematic risk....

Measuring Diversification

Generally, it is quite a herculean task to measure diversification. However, financial experts, financial analysts, and portfolio managers use certain measurements to calculate the diversification of portfolios....

Example of Diversification

Suppose, there is an aggressive investor. He/she wants to take higher risk and build, a portfolio comprising Japanese stocks, Australian bonds, and rice futures. For the stocks and bonds, the investor invests in ETFs and future derivatives. With this ensures a mixture of funds, the investor ensures diversification in its holdings. The different assets ensure lesser risk and higher returns....

Frequently Asked Questions (FAQs)

1. What are the benefits of diversification?...