When you’re on a job hunt, you’ll likely send applications to different companies to increase your chances of landing a good role.
You may even consider a range of industries and positions to have more options. As the saying goes, you don’t want to put all your eggs in one basket.
This phrase is also often used as a piece of investing advice. It warns investors against putting all their money in just 1 or very few investments since this approach can leave them highly vulnerable to losses.
Instead, they are told to practice diversification, a risk management method that can prove useful in your investing journey. Learn more about it below.
What is diversification?
Diversification is a strategy that involves spreading your money across different types of investments to reduce risk.
This way, even if 1 investment loses value, others might do well, and you may still end up growing your money overall.
To properly diversify, you can allocate your money across different asset classes (like stocks and bonds), across sectors and industries, and sometimes, even across countries.
Another way to diversify is to get a mix of products that fit varying risk profiles and time horizons.
What are the benefits of diversification?
The idea behind diversification is that different kinds of investments may perform differently under the same circumstances or economic conditions.
For example, when interest rates are high, interest-bearing investments like bonds tend to attract more investors. Less people may put money in stocks during such times, driving stock prices down.
Aside from reduced risk, diversification may offer other benefits. You may find new opportunities to possibly grow your money by exploring different kinds of investments.
After all, there are various ways to earn money through investing. Some investments generate regular income, others offer growth through capital appreciation, while certain products may provide both.
Is diversification always effective?
No investing strategy is foolproof, and that includes diversification. While it helps to reduce risk, it doesn’t eliminate it completely.
You may not be able to fully diversify against certain large-scale events or types of risk. This includes systematic risk, which affects the overall market and not just specific kinds of investments.
You should also be cautious about too much diversification. Overdiversification happens when a portfolio holds too many investments. Each new addition may end up lowering potential returns more than they reduce risk.
Diversification is important, but it’s also crucial to maintain a well-balanced portfolio. A regular review will help you keep your portfolio updated according to your needs and changing situation.
