The importance of diversification in managing an investment portfolio

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The importance of diversification in managing an investment portfolio

It can be a rather basic and easy to understand concept. However, in its implementation, many investors make catastrophic mistakes with too much concentration and others settle for average performance because of over diversification. Definition of Diversification The definition of diversification is the act of, or the result of, achieving variety.

In finance and investment planning, portfolio diversification is the risk management strategy of combining a variety of assets to reduce the overall risk of an investment portfolio.

Purpose of Portfolio Diversification The purpose of portfolio diversification is portfolio risk management. A risk management plan should include diversification rules that are strictly followed. Portfolio diversification will lower the volatility of a portfolio because not all asset categories, industries, or stocks move together.

The importance of diversification in managing an investment portfolio

Holding a variety of non-correlated assets can nearly eliminate unsystematic risk specific risk. In other words, by owning a large number of investments in different industries and companies, industry and company specific risk is minimized. This decreases the volatility of the portfolio because different assets should be rising and falling at different times; smoothing out the returns of the portfolio as a whole.

Portfolio optimization can be achieved through proper diversification because the portfolio manager can invest in a greater number of risk assets i. In other words, portfolio managers with a target amount of total risk are able to invest a greater percentage of their assets in risk assets with a diversified portfolio versus a non-diversified portfolio.

This is because holding a variety of non-correlated assets lowers the total risk of the portfolio. This is why some say diversification is the only free ride.

Some lessons can be over learned.

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Over diversification is almost as large a problem today as under diversification. It is common for investors to believe that if a given amount of diversification is good then more is better. This concept is false. If adding an individual investment to a portfolio does not reduce the risk of the total portfolio more than it costs in potential returns then further diversification would be over diversification.

Most experts believe 12 — 25 individual investments are sufficient to reduce unsystematic risk. Diversification There is a debate between investors who believe in concentration and those that believe in diversification.

My belief is there are few stock analysts competent enough to concentrate in less than 10 stocks. Intense concentration leaves no room for errors in your analysis.

It also inflicts a large penalty when something unforeseen causes a severe reduction in price of a single stock or a particular industry. Those who concentrate in one stock are particularly at risk.Here's Why Diversification Matters investment diversification as "a portfolio strategy combining a variety of assets to reduce the overall risk of an investment portfolio.“.

Your investment portfolio could reap the benefits of diversification. Learn about portfolio diversification and what it means to diversify your investments. The importance of diversification When it comes to creating an investment portfolio to help you maintain your quality of life during retirement, most experts agree that diversification is a good option for achieving desired returns while managing risk.

Investment portfolio diversification is a tried and tested technique that involves reducing risk by spreading investments across a varying range of companies, sectors, geographical locations and assets. Obviously, diversifying your investments is not an absolute buffer against financial losses.

Diversification is the practice of spreading your investments around so that your exposure to any one type of asset is limited. This practice is designed to help reduce the volatility of your portfolio over time.


One of the keys to successful investing is learning how to balance . The most basic – and effective – strategy for minimizing risk is diversification. A well-diversified portfolio consists of different types of securities from diverse industries, with varying.

The importance of diversification in managing an investment portfolio
The Importance Of Diversification | Investopedia