Diversification is the process of allocating available resources to multiple projects so they will be able to reduce the exposure to any specific risk. It is the risk management that investors use to avoid the significant impact of the particular risk of the asset. This method combine all asset into one portfolio, all assets have a different kind of risk. So if anything happens to a few assets, the whole portfolio will not have a huge impact. There will be some assets that get positive profit so it will net off with a risky one.
A portfolio will consist of any kind of assets which come from different industries, geographical location, and type of investment. The more diversified, the less risk it will impact when one or two assets are not performing well.
Company ABC allocates $ 5 million to invest in bond and share in the capital market. Management tries to diversify by divide the total budget into several shares. The portfolio includes a share of the trading company, manufacturing, real estate, and so on. The company has allocated the capital to purchase shares from different industries. So if one industry collapse, it will impact only a portion of the investment.
Important of Diversification
- Reduce the risk of the whole assets: If we invest in only one asset, it is very risky when the asset impact by any particular event. Event one or two assets not doing well, there will be a low impact to the investors.
- Increase return: Diversify allow the investors to gain profit from different asset, even one asset not perform well, other assets will be able to cover the loss. As the result, the gain from the whole portfolio remains at a good level.
- Expose to more opportunities: The more diversification, the more opportunities we get from the investment. As we invest in more assets, there will be more opportunities for us.