What Is Industry Diversification?

Mary McMahon

Industry diversification refers to investments made across a broad range of industries to limit exposure to risk. It is one approach people may choose to take to an investment strategy to have greater access to earnings with less of a chance of taking major losses. People can create their own portfolios, making decisions about how to weight investments and where to keep funds. They can also turn to a financial consultant for assistance with developing a diversified portfolio, or for complete management services, where the consultant also takes care of day to day handling.

An investor might want to invest in a variety of industries, such as finance, electronics, and pharmaceutical products.
An investor might want to invest in a variety of industries, such as finance, electronics, and pharmaceutical products.

Heavy investment in one industry can be a bad investment move. If the market in electronics is doing well, it may be tempting to invest primarily in high-performing electronics companies. This may result in high profits while the market continues to do well. As soon as the market falters and those companies start to experience falls in value, the investor can be hit heavily with a drop in overall portfolio value because of the lack of industry diversification. It is not enough to invest in several different firms within an industry, but to spread investment out between several industries.

The right mix of industries for a portfolio can depend on the investment plan and current economic conditions. People may include 10 or more sectors for optimal industry diversification, investing in different industries like financial services, electrical components, and pharmaceutical manufacturing. They can decide which percentage of the portfolio to generate to each kind of asset, and keep their investments within each industry diverse to further spread risk.

A decline in one industry doesn't drag the rest of a portfolio down when it makes up only a small percentage of holdings. It’s also possible to divest assets more quickly when an investor isn’t holding large numbers of them. As warning signs suggest that an industry might be in trouble, for instance, an investor can reduce investment in that area while keeping the rest of the portfolio balanced. Industry diversification may allow for more flexible, adaptable investing, which can be important in rapidly-moving markets.

Careful research is an important part of industry diversification. People need to know where the growth sectors are, and what kinds of projections have been made about the future of industries of interest. They should also consider which investment products within each industry are the most likely to provide a solid yield. Portfolios can also be balanced with other investments, like government bonds, in order to create a solid backbone with stable returns.

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