Diversification Reduces Risk

It is a wise idea to follow the old adage “Don’t keep all your eggs in one basket” while one is thinking of investing one’s hard earned money.

These days there is a plethora of options wherein the money can be invested. Banks considered being the safest form on one end of the continuum, whereas stock markets considered being the riskiest form on the other end.

The traditional and conventional school of thought says that the money should be saved in a bank which would give a nominal rate of interest. There would be no risk in leaving the money there.

The next step of the ladder is ‘investing’ wherein one purchases something that may gain or lose value. Yes, there is risk involved, but then one is rewarded for the extra risk one takes. In fact, it is well known in financial circles that higher the risk, higher the gain.

As mentioned above, there are surfeit options to invest in for e.g. stocks, mutual funds, real estate, bonds, debentures et al. The most prudent thing to do is to create a judicious blend of ones investments.

In other words one should choose to invest in more than one option, so that if there was a loss in one, it wouldn’t all happen at the same time. Conversely, if one investment does well, all the money will not be there.

No doubt, by diversifying the portfolio, one caps his upside potential, but then, at the same time, one caps his downside potential also. The power of diversification allows one to own a chunk of many different properties. Even if one of them fails, the others act as a cushion.

Diversification may be boring than investing and speculating in stocks, but it acts as a shield when the market corrects. Whether one subscribes to this theory or not it depends on the risk appetite of the individual.