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Asset
& Risk
Diversification
Diversification
in finance is a risk
management technique,
related to spreading out
your risk among various
assets that can bring
you a return on your
money. The goal of
many investors is to
make the most profit
from their investments
while making sure to
minimize their risk.
The way that investors
may accomplish this goal
is by making a wide
variety of investments
within a portfolio to
reduce risks. Diversification
may be familiar too many
people from the old
adage “never put all
your eggs in one
basket”. The
simple reason for this
is that if something
happens to that single
basket then you have
nothing.
Investments are subject
to change and
fluctuations. If
you simply own a single
security then you are
more at risk of losing
everything, whereas if
you own a variety of
securities then a
fluctuation in one
security should have
less impact on a diverse
portfolio. Simply
stated, diversification
minimizes the risk from
any single investment
security.
Examples
of Diversification
- Spread
the portfolio among
multiple investment
mediums, such as
stocks, mutual
funds, bonds, real
estate and cash.
- Spread
the risk in the
securities. A
portfolio may also
be diversified into
different mutual
fund investment
strategies,
including growth
funds, balanced
funds, index funds,
small cap, and large
cap funds. This
would be a way of
spreading your risk
so that all your
eggs would not be in
one basket if there
were dramatic
fluctuations in one
type of fund.
As a result, a
diversified
portfolio would
likely have
investments with
variety of risk
levels (e.g. growth
fund, balanced fund,
large cap funds,
small cap funds,
bond funds), a huge
loss in a particular
area of the market
may be offset by
other areas.
- Spread
the securities by
industry, or by
geography. This
will minimize the
impact of a certain
industry- or
location-specific
risks. One example
of diversification
across geography
would be having a
domestic market fund
and an international
fund. By
selecting a fund
that has investments
in many countries,
events within any
one country's
economy would likely
have less effect on
the overall
portfolio.
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