Diversification

Definition: Diversification is a risk management strategy that refers to spreading your investments across different asset classes to reduce the overall risk of your portfolio.

What is Diversification?

Diversification is a risk management strategy that refers to spreading your investments across different asset classes to reduce the overall risk of your portfolio. The idea behind diversification is that by investing in a variety of assets that are not perfectly correlated with each other, the performance of your portfolio will be less affected by the ups and downs of any one asset or market.

For example, instead of investing all of your money in stocks of one particular company or sector, you may choose to invest in a mix of stocks, bonds, and other assets such as real estate or commodities. You may also diversify your stock portfolio by investing in companies across different industries or geographic regions.

Why is Diversification Important?

Diversification can help reduce exposure to risks such as market volatility, changes in interest rates, geopolitical events, and company-specific risks. By spreading your investments across different asset classes and markets, you can minimize the impact of any single investment on your overall portfolio.

Take the 2008 financial crisis. Investors who had their entire portfolios concentrated heavily in the real estate or financial sector suffered significant drawdowns. However, diversifying into bonds, other industries, or other securities that are inversely correlated with the market minimizes downside risk if the market goes belly-up.