Diversification is a means of reducing risk and increasing opportunity in investing. The chances of having a stock in your portfolio rise significantly in price goes up when you have five well-chosen stocks instead of one. The chances of losing all of your investment capital also go down when you diversify your investment portfolio among several stocks in several market sectors. Likewise, if a part of your investments is in property, a part is in stocks, a part is in bonds, and a part is in offshore investments you can reduce risk and increase the opportunity for profits. When suggesting offshore investment opportunities we wrote about Three Good Offshore Investment Ideas, for example.
Diversify Your Investment Portfolio to Gain Variety and Opportunity
When you diversify your investment portfolio you invest in a variety of assets. Because the value of each investment does not go up or down in perfect harmony, diversification averages out risk, as well as gain. To the extent that one is looking to a big gainer, having more stocks, real estate, or other assets may serve to increase the odds of success. In their book A Random Walk Down Wall Street the authors note that the best return in stocks is often a basket of about forty small cap stocks. These stocks are priced low because of the risk inherent in small companies. However, if you diversify your investment portfolio with a large number of these stocks, you increase the chances of finding a huge winner which will negate the effects on the portfolio of a handful of losers.
There Is Always a Bull Market Somewhere
Not all investment vehicles go up and once or down at once. As an example, when the price of oil goes up, the price of oil company stocks generally rises. At the same time the prices of industrial stocks, hit by the higher price of energy, typically go down. By investing in stocks in several sectors you can often average out gains and losses. The idea here is not to hedge risk only, however. Each stock, each investment needs to be looked at with thorough fundamental analysis in order to pick investments with a high expected rate of return and a significant margin of safety against loss during bad times. To the extent that economies like those of the BRICS nations are rising faster than those of Europe or North America, it may be wise to diversify your investment portfolio with emerging markets in mind. To the extent that there is a transparency problem when investing in China, Russia, India, Brazil, or South Africa, it is often wise to diversify your investment portfolio with an eye toward keeping part of your money in North America.
Choice of Investments when You Diversify Your Investment Portfolio
Diversification is not a substitute for simply picking good investments. Investing in gold can be a good idea under the right circumstances as can investing in beer be a good idea. Investing in oil, investing in China, and picking new winners in high tech stocks can all be profitable undertakings. However, a smart investor picks his stocks wisely, routinely watches each investment in his portfolio, and buys and sells investments accordingly. When you diversify your investment portfolio you do not commit to a “buy and hold” strategy. Rather you choose investments that fit a rational approach aimed at increasing opportunity while also reducing investment risk.
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