What is portfolio diversification?
Portfolio diversification is a method of risk management that involves investing in a variety of assets to reduce risk and maximise return.
This strategy is extremely important in portfolio management.
Where have you heard about portfolio diversification?
Diversification is something you’ll come across when looking into the basics of investing. There are countless articles offering advice on how to diversify and why you should diversify (such as this article from the Money and Advice Service ), as well as the effects of ‘diworsification’, a term coined by Wall Street trader Peter Lynch, about the negative effects of overdiversification.
What you need to know about portfolio diversification...
It’s important to understand that diversification doesn’t guarantee gain without loss, it is simply a strategy to balance the risk associated with investing. Experts say that a successful portfolio ideally has between 25 and 30 stocks.
To diversify your portfolio effectively, you need to balance your investments by spreading them across a variety of assets. Some asset classes are high risk, with the potential for big reward, while others may be lower risk with small potential for return. Using a mix of these ensures you are not too vulnerable either way.
Greater diversification does not necessarily equal further reduced risk. In fact, diversifying too much limits the potential for your investments so much that it can negatively affect your investments. This is overdiversification.