Investment Insights
Successful savers and investors do not put all their eggs in one basket. Instead they look for exposure to multiple assets and instruments to reduce risk. When saving or investing through a single asset only, an investor has significant exposure when the price of that asset goes up or down. Yes, if it goes up, he or she might earn a good return, however if the price moves against them so their wealth will fall. Spreading risk across multiple investments and savings vehicles is known as diversification.
Diversification is not an exact science and is something that is unique to each portfolio and the investor's or saver's goals. There is a misconception that diversification means purchasing many assets in a portfolio and the more assets one has the better diversified the portfolio. For example, simply increasing the number of shares in a share-only portfolio does not assist in balancing overall portfolio risk, as increasing shares is only effective to a certain point as seen on the graph below:
Limits of diversification in equity-only portfolio
Source: Rack Education
Of course, by increasing the number of shares in your portfolio you can diversify away company specific risk. But market risk remains regardless of how many shares you invest in.
Tips for diversifying effectively :
