Diversification

Diversification
Source: Tavaga

Diversification is the practice of investing in different asset classes, or securities within asset classes, to reduce unsystematic risk in an investment portfolio by as much as possible.

What is diversification in business?

Diversification for an enterprise, on the other hand, would mean branching out into other businesses to offset risks to the revenue stream of its core business. It means going for a company that is not affected by the factors by which current business is affected.

How to diversify?

Diversification can be done in the following ways:-

  1. Investing in different types of assets like gold, equities, bonds, etc
  2. Investing in Fund Of Funds
  3. Investing in Mutual Funds or Exchange Traded Fund
  4. Investing in foreign exchange markets
  5. Investing in stocks of different indexes
  6. Investing through a portfolio manager with thorough research

Why is diversification important?

Diversification helps an investor with reducing the risk in their portfolio without affecting the returns by a large degree. It helps to achieve returns greater than the index. For ex:- If the money is invested in all the stocks of a particular index, it will lead to all of them getting affected to some extent if the index underperforms, whereas investing in some stocks of another index will help in offsetting the risk.

How does diversification reduce risk?

It helps in reducing risk as to the same sectoral, or industrial changes will not affect every asset in the same way. They react differently. For ex:- change in the import-export policy of the U.S.A may affect China negatively, but it will lead to more imports & exports from Indian markets, which will react to this event positively. 

During COVID-19, the Pharma sector has suffered moderately, whereas tourism and hospitality are severely affected. Investing in a combination of these stocks would have helped investors to offset the losses.