THE MEANING BEHIND DIVERSIFICATION

Diversification means dividing your investment among a variety of assets. Diversification helps to reduce risk because different investments rise and fall independently of each other. The combinations of these assets more often than not will cancel out each others' fluctuations, therefore reducing risk.

Diversification in investments can be achieved in many different ways. Individuals can diversify across one type of asset classification—such as stocks. To do this, one might purchase shares in the leading companies across many different (and unrelated) industries. Many other diversification strategies are also possible. You can diversify your portfolio across different types of assets (stocks, bonds, and real estate, for example) or diversify by regional decisions (such as state, region, or country). Thousands of options exist.

Luckily, in almost every effective diversification strategy, the ultimate goal is clear—to improve performance while reducing risks.

Two basic types of risks associated with investments are unsystematic risk and systematic risk.

Let us see how diversification may be able to help investors reduce these risks.