Diversification
 |
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 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. |
Related Definitions
Articles Of Interest
-
4 Steps To Building A Profitable Portfolio
This is a step-by-step approach to determining, achieving and maintaining optimal asset allocation. -
Introduction To Investment Diversification
Reducing risk and increasing returns in your portfolio is all about finding the right balance. -
Major Blunders In Portfolio Construction
Do you have the best mix of investments? Find out how to make sure. -
The Importance Of Diversification
Without this risk-reduction technique, your chance of loss will be unnecessarily high. -
Do You Understand Investment Risk?
Many investors overestimate their level of financial knowledge. -
Top 4 Signs Of Over-Diversification
Learn how to spot over-diversification in your portfolio and find out why some financial advisors are motivated to do it. -
The Dangers Of Over-Diversifying Your Portfolio
If you diversify too much, you might not lose much, but you won't gain much either. -
Achieving Optimal Asset Allocation
Minimizing risk while maximizing return is any investor's prime goal. The right mix of securities is the key to achieving it. -
Behavioral Bias - Cognitive Vs. Emotional Bias In Investing
We all have biases. The key to better investing is to identify those biases and create rules to minimize their effect. -
Why Your Pension Plan Has Sovereign Debt In It
One type of security pensions tend to invest in is sovereign debt, or debt issued by a government.
Free Annual Reports
