You probably have heard of stories about people losing all their money, when a particular stock crashed to bottom. They invested thousands of dollars into one stock, confident that this stock would skyrocket to the moon. Instead, that stock crashed to the bottom, plummeting all the investors to oblivion. These investors forgot the most important thing they should do, and that is diversification.
Diversification is a strategy that reduces your risk by allocating investments. The obvious way to diversify your investments is to invest in different sectors or categories. This includes stocks, bonds, forex, real estate, mutual funds, gold, oil, and other commodities.
By doing diversification, you’ll lower your overall risk. The more you spread your assets, the less your portfolio will have a negative impact from a single event. It also aims to maximize return by investing in different areas that would each react differently to the same event.
For example, when stock prices drop, bond prices rise because investors put their money into a less risky investment.
While it’s wise to diversify in different types of companies, it’s also more ideal to invest in different types of industries.
Remember the dot-com bubble that happened between 1995 and 2001? This was when investors invested heavily on internet-based startup companies in hopes that these companies would soon turn a profit.
The bubble started to collapse in 1999, and by 2001, the bubble burst, taking many internet-based companies crashing.
Furthermore, you have to remember that it’s essential to make your investments uncorrelated with each other. Remember, the more uncorrelated your stocks are, the better.
Let’s take a good example of a portfolio that consists of fast food stocks only. If it is announced that one fast food chain poisoned thousands people, its stock prices would go down. This will hurt your portfolio badly.
However, if you balanced out your fast food stocks with coffee stocks, like Starbucks, only part of your portfolio would be affected. There is also a potential that coffee stock prices would jump. Customers might turn to coffee chains instead of eating and getting poisoned at a restaurant.
And you could do diversification further because there are still risks that affect both fast food and coffee chains as they are involved in the food industry stocks. They are highly correlated with each other.
So to sum up about diversification, first, you have to spread your money among different assets categories, and then further diversify that money within each category.
While diversification can help you manage risk and reduce the volatility of an asset’s price movement, it still doesn’t eliminate the risk completely. Make sure that you review your investments at least every year. Look for investments that are working and what’s not, and then make changes promptly.
There are still thousands of tips you can see in reviews of online trading platform. Or you could get a reliable broker like HQBroker to help you in diversification. Don’t be one of those investors who pump all their cash into one investment. Even if you think that this particular stock is good, remember that the general market is still unpredictable.