In this lesson you will learn 💸
- What diversification means
- Why diversification is fundamental to lower your risk and to increasing your potential for improving returns
What is diversification?
Diversification remains the cornerstone of a proper investment strategy. Whether you devise that yourself, or you seek professional advice, your ultimate goal is to spread your risk and increase your odds of investment success.
Diversification is important because markets can be volatile and unpredictable.
While some assets may respond well to a global news story, others may take a nosedive. For example, when the economy is growing, stocks tend to outperform bonds. In a slowing economy, bonds often perform better than stocks. Holding both stocks and bonds reduces your risk of taking a big hit when markets swing one way or the other.
Example 🍓🍋
Let’s say you run a fruit stall. If you only sell oranges from one supplier in Seville, and there is a drought in Spain, you risk losing everything. However, if you sell apples, oranges and bananas from various stockists around the world, you’ll still have stock to sell in the event of a natural disaster.
Even if one of your apple suppliers lets you down, you’ll have other apples to sell. In this example, your apples, oranges and bananas are your asset classes. Your different suppliers are your assets within each asset class.
How can I diversify my investments?
You have various options to diversify your investments:
- Include different asset classes as they behave differently, for example stocks, bonds, gold
- Invest in different geographies, for example developed and emerging markets
- Invest in different industries or sectors, for example healthcare and energy producers
- Include different currencies