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What is Portfolio Diversification?

Article Details
  • Written By: Felicia Dye
  • Edited By: J.T. Gale
  • Last Modified Date: 15 May 2018
  • Copyright Protected:
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    Conjecture Corporation
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In the financial world, a portfolio generally refers to a person’s investments. Portfolio diversification is an investment strategy that attempts to reduce an investor’s risk and accent his or her gains. This is achieved when a person decides to have varying investments.

If a person takes all of the resources that he or she has for investing and puts them into one thing, he or she cannot say that the investments are diverse. Investing in this manner also commonly involves a great deal of risk. Some investments result in losses. When all of a person’s resources are invested in one thing, those losses can be substantial.

To prevent this from happening, investors are generally advised to make varying investments. If there is one investment that an investor prefers, he or she may wish to contribute to it substantially. He or she does not, however, have to contribute solely to it.

Portfolio diversification does not have to involve different types of investments, but it can. For example, if a person only feels comfortable investing in stocks, his or her portfolio can be diverse as long as it is invested in more than one stock. If he or she is comfortable making other types of investments, however, he or she may branch out and invest in bonds, mutual funds, or real estate.

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Mutual funds are a simple way to diversify. A mutual fund is basically a collection of investments that are preselected. If a person does not want to deal with choosing several individual investments, investing in a mutual fund will allow him or her to put all of the money into one place while actually having it invested in different things. This option, however, does not offer everyone as much diversity as they might like.

Another benefit of portfolio diversification is the potential rewards. Some investments grow faster than others. In many cases, the investments that grow the fastest have the most risk. A person may be uncomfortable putting too many resources into high-risk investments. Allocating a small portion of resources to such investments can, however, result in impressive returns.

Portfolio diversification is a strategy that is suitable for all types of investors. Whether an investor is aggressive or conservative, he or she can still aim to minimize risk and improve gains by varying investments. Those who choose this strategy, however, should be sure to apply it wisely.

Some people make the mistake of believing that they can dedicate less thought to choosing their investments if they invest in several things. Such ideas should be avoided and careful consideration typically should be given to each chosen investment. It is also important to realize that over-diversification can have a negative effect on a portfolio. The amount of resources that a person allots for investment typically should not be spread too thin.

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