Diversification is a technique that cuts down on the risk factor by allotting investment in various financial objects or instruments. It has an aim to increase different areas by investing in several areas which would react in a different way to the same event.
Diversification, many experts agree that it does not guarantee that you wouldn’t face loss, but it is the most important component towards reaching a long-term financial goal while minimizing risk as much as possible.
Why Should You Diversify?
To get a clear idea, let’s say you have a portfolio of airline stocks. Suppose, one day, the pilots decide to go on a strike. Your Portfolio Diversification will experience loss because of it since all flights will be canceled and airline share prices will drop considerably.
If, however, to balance out the loss, you decide to buy railway stocks, then only a part of your portfolio will be lowered. In fact, it will be a sound decision since people turn to railways, more, for an alternative form of transportation.
But there is a slight chance that both your railways and your airline portfolio will be affected. Hence, you should diversify across the board, and not only to different types of companies but also to different industries. Since transport is correlated, look for an industry that is not at all related.
There exist other forms of diversification and many investment products all around have been created solely to harbor investor’s risk factors, that is, it lowers risks. However, choosing such products might turn out to be dangerous and complicated for new investors or small investors. Investors who have less or lower investment experience, and who do not have the financial support of backing to enter into several high paced activities, bonds are the alternative for them which are also the most famous way to diversify against the stock and share market.
Unluckily, even the best experts or analysts of a company, not even their financial statements can give you the ultimate word that you won’t be facing a loss in this industry and that what you’re investing in won’t be a losing investment. Although Diversification cannot prevent you from losing or facing a loss, it can decrease the final impact of fraud and spread of information of your portfolio.
In conclusion, it can help an investor reduce considerable risk and reduce the possibility of fraud and foul play, but remember, to have the point in mind that no matter how much you end up diversifying your portfolio, the general risk that everyone faces with can never be completely eliminated from the final thing.
Risk can be reduced connected with investing in an individual stock, but general market risks are the downside that affects every investor in nearly every stock. And so, it is to be kept in mind that you should diversify among different assets. The main thing is to find out a way to have a happy balance between risk and return.
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