Risk and Diversification: Diversifying Your Portfolio
AAA
  1. Risk and Diversification: Introduction
  2. Risk and Diversification: What Is Risk?
  3. Risk and Diversification: Different Types of Risk
  4. Risk and Diversification: The Risk-Reward Tradeoff
  5. Risk and Diversification: Diversifying Your Portfolio
  6. Risk and Diversification: Conclusion

Risk and Diversification: Diversifying Your Portfolio


With the stock markets bouncing up and down 5% every week, individual investors clearly need a safety net. Diversification can work this way and can prevent your entire portfolio from losing value.

Diversifying your portfolio may not be the sexiest of investment topics. Still, most investment professionals agree that while it does not guarantee against a loss, diversification is the most important component to helping you reach your long-range financial goals while minimizing your risk. Keep in mind, however that no matter how much diversification you do, it can never reduce risk down to zero. (For related reading, see Introduction To Diversification and The Importance Of Diversification.)

What do you need to have a well diversified portfolio? There are three main things you should do to ensure that you are adequately diversified:

  1. Your portfolio should be spread among many different investment vehicles such as cash, stocks, bonds, mutual funds, and perhaps even some real estate.
  2. Your securities should vary in risk. You're not restricted to picking only blue chip stocks. In fact, the opposite is true. Picking different investments with different rates of return will ensure that large gains offset losses in other areas. Keep in mind that this doesn't mean that you need to jump into high-risk investments such as penny stocks!
  3. Your securities should vary by industry, minimizing unsystematic risk to small groups of companies.
    Another question people always ask is how many stocks they should buy to reduce the risk of their portfolio. The portfolio theory tells us that after 10-12 diversified stocks, you are very close to optimal diversification. This doesn't mean buying 12 internet or tech stocks will give you optimal diversification. Instead, you need to buy stocks of different sizes and from various industries.
Risk and Diversification: Conclusion

  1. Risk and Diversification: Introduction
  2. Risk and Diversification: What Is Risk?
  3. Risk and Diversification: Different Types of Risk
  4. Risk and Diversification: The Risk-Reward Tradeoff
  5. Risk and Diversification: Diversifying Your Portfolio
  6. Risk and Diversification: Conclusion
RELATED TERMS
  1. Risk Financing

    The determination of how an organization will pay for loss events ...
  2. Captive Value Added (CVA)

    The financial benefit that an organization would gain by using ...
  3. Sharpe Ratio

    A ratio developed by Nobel laureate William F. Sharpe to measure ...
  4. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets ...
  5. Bornhuetter-Ferguson Technique

    A method for calculating an estimate of an insurance company’s ...
  6. Average Severity

    The amount of loss associated with an average insurance claim. ...
  1. How attractive is the internet sector for a growth investor?

    Learn why the Internet sector is an attractive option for growth investors, as well as what many of them do to reduce the ...
  2. What trading strategies help investors withstand a drawdown?

    Understand the concept of drawdown and the importance for traders of having a trading strategy that takes temporary drawdown ...
  3. Are there leveraged ETFs that track the banking sector?

    Learn about some of the leveraged exchange-traded funds (ETFs) that investors can use to track the banking industry within ...
  4. When is an expense ratio considered high and when is it considered low?

    Discover what is considered an exceptionally high or low expense ratio for a mutual fund or ETF, and learn why this figure ...

You May Also Like

Related Tutorials
  1. Bonds & Fixed Income

    Investing For Safety and Income Tutorial

  2. Economics

    American Depositary Receipt Basics

  3. Investing Basics

    Stock Basics Tutorial

  4. Options & Futures

    Beginner's Guide To Trading Futures

  5. Trading Strategies

    Introduction To Order Types

Trading Center