Diversification may be defined as the act of lowering the potential risk by not allowing all of the income to come from just one source.
In order to understand diversification better, there are multiple examples from everyday life. If you are playing the roulette and not putting all of your chips on just one number but rather spread them on several fields, that’s diversification. If you want to resell some product but you decide to buy several different ones and see which one shows to be the best selling, that’s also diversification.
Diversification is mainly a financial term. It refers to investing in multiple assets, so, if some of them fail, there would be others remaining. When buying stocks, one should choose from various industries, company sizes, geographical locations and business types. Even choosing at random is recommended, since there is no the right formula for making the ultimate diversified portfolio.
Experts claim that having a portfolio with various investments will make the expected return higher and the overall risk will be lower.
Due to the limited budget, many people have problems with creating the desired diversified portfolio. The solution for that problem has been found in the mutual funds. They are getting more and more popular. By joining a mutual fund one is able to have a portfolio with high diversification without having to invest huge amounts of money..
Geographical diversification has more advantages than it may seem at first. Since international economies are usually not directly connected to each other, owning stocks in some other country can turn out to be very beneficial in some cases.
One of the ways diversification can be achieved is to combine real estate, stocks and bonds. With such a variety, one can not expect huge financial gain, but the risk is also on the minimum. For example, if the stocks loose their value, it won’t all be lost, since the real estate and bonds will remain. Those with a gambling trait might not like this approach, because it reduces the upside potential, too. Diversification won’t help those who want to earn money fast. Instead, it provides stable circumstances for working under many economic condition and not be afraid that one bad decision can cost one way too much.