What is diversification? It can be defined as the act of varying your assets or properties to a multiple sources. In effect, you can reduce your risks. A simple explanation would be to put your eggs in more baskets instead of one only.
How does this apply in investments? If you follow the idea of diversification, then you need to carefully rethink your investing strategy. You should place your money in different investments with returns that are not related to each other.
Why is this so? This is because some investments will fail at times. The good news is, your other investments will prosper. You can thank your strategy for buying investments that are different altogether in terms of their returns. This increases your chances of earning a net profit, in a bigger picture.
What kind of investments should you diversify to? Well, there are many to start with. The common few include stocks, real estate, bonds and even starting your own business. Consider the domestic and international markets for your investment platforms. Spread your assets by selecting different types of investments.
Let us talk about stocks as an example. You have to realize that when you invest in stocks, you must select the ones that perform well under all kinds of economic situations. This is a very important criterion when choosing a stock. This is why mutual funds are created. They are simply the diversified portfolios of securities consisting of stocks and bonds.
Therefore, what happens when you buy a mutual fund? You are actually investing your money together with thousands of people in a sea of stocks and bonds. Mutual fund itself is a diversified investment alone.
You should now be aware that diversification brings you 2 other benefits. When you diversify, you are reducing your volatility in the value of your whole investment portfolio. Compared to when you are investing in a single source only, your diversified investments are capable of fewer fluctuations in value over time.
Diversification actually gives you a higher rate of return. This applies when there is a certain amount of risk involved, like all investments do.
In the real world, not a single person can predict the future of the market. Therefore, it is suffice to say that nobody can say a single investment type is the best. No single stockbroker can guarantee you a specific number of profit. There are cases when people do get lucky. However, that would akin to gambling; depending on luck. In conclusion, diversification simply reduces your risks when you invest.