Diversification

Dictionary Says

Definition of 'Diversification'

A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique contends that a portfolio of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio.

Diversification strives to smooth out unsystematic risk events in a portfolio so that the positive performance of some investments will neutralize the negative performance of others. Therefore, the benefits of diversification will hold only if the securities in the portfolio are not perfectly correlated.
Investopedia Says

Investopedia explains 'Diversification'

Studies and mathematical models have shown that maintaining a well-diversified portfolio of 25 to 30 stocks will yield the most cost-effective level of risk reduction. Investing in more securities will still yield further diversification benefits, albeit at a drastically smaller rate.

Further diversification benefits can be gained by investing in foreign securities because they tend be less closely correlated with domestic investments. For example, an economic downturn in the U.S. economy may not affect Japan's economy in the same way; therefore, having Japanese investments would allow an investor to have a small cushion of protection against losses due to an American economic downturn.

Most non-institutional investors have a limited investment budget, and may find it difficult to create an adequately diversified portfolio. This fact alone can explain why mutual funds have been increasing in popularity. Buying shares in a mutual fund can provide investors with an inexpensive source of diversification.

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Articles Of Interest

  1. Introduction To Investment Diversification

    Reducing risk and increasing returns in your portfolio is all about finding the right balance.
  2. Top 4 Signs Of Over-Diversification

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  3. The Importance Of Diversification

    Without this risk-reduction technique, your chance of loss will be unnecessarily high.
  4. The Dangers Of Over-Diversifying Your Portfolio

    If you diversify too much, you might not lose much, but you won't gain much either.
  5. Risk and Diversification: Diversifying Your Portfolio

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  9. Major Blunders In Portfolio Construction

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  10. Should You Invest Your Entire Portfolio In Stocks?

    It is true that stocks outperform bonds and cash in the long run, but that statistic doesn't tell the whole story.

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