Diversification is the golden rule of investing.
When experts talk about diversification, it means investing in uncorrelated investment products, each offering different yields and risks, rather than sinking all your money into one company’s stock or one sector of the market.
The benefits of diversification are in minimizing risk without severely damaging your potential for profit. But what does this mean practically?
5 Benefits of Diversification
Do you know the benefits of a diversification investment strategy? Here are 5:
1. It Reduces Risk
Risk reduction is the core of investing because risk is inherent in the entire process.
The diversification of a portfolio should be done to avoid risk because it ensures that if one market tanks, your assets are spread out evenly enough to remain somewhat secure (unless all markets fail).
Think of it this way: if you put all your money under your bed, and your house burns down, then every dollar you have goes up in flames.
But if you put some of your money under the bed, bury some in the backyard, and do the sensible thing by putting the rest in the bank, only the money you stuffed in your mattress is lost.
2. Benefit from Capital Preservation
If your goal is to grow your wealth slowly and implement a capital preservation strategy, then diversification is the place to do it. With the risk reduction and opportunities to hedge your investments, you’ll likely see manageable growth without the investment of time, energy, and resources required in focused portfolios.
3. Diversification of a Portfolio Means Less Maintenance
Investing heavily in one sector or market requires regular observation and maintenance as well as some buying and selling to keep your portfolio earning money. Letting a big investment sit opens you up to risk.
When you have a smaller amount of money invested in more places, you’ll spend less time (and money) maintaining those accounts because both the risks (and windfalls) are less severe.
4. More Likely to Enjoy a (Smaller) Windfall
Windfalls occasionally happen, and when they do, it always seems to be in the sector you’re not invested in.
Diversification allows you to put your eggs in many baskets to maximize your opportunity to enjoy a windfall. Of course, you won’t enjoy the maximum profit because your holdings might be small, but a windfall on 10% of your investments is better than no windfall at all.
5. You’re Less Exposed (Darling)
Like George Clooney in Intolerable Cruelty, staying planted in a single market or sector means you’re exposed. If that market falls or even disappears, so too will your investments.
Just as it’s better to enjoy a small windfall than none at all, it’s better to lose a fraction of your investments then the whole nest egg.
Diversify, Diversify, Diversify
It’s important to remember that diversification doesn’t protect you from a loss in any area, but it can reduce your risk. In fact, this is at the core of most of the benefits of diversification.
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