Diversification is a strategy used to spread investments across different assets, sectors, or geographical areas to reduce the overall risk of a portfolio.
The idea is that different assets often react differently to the same economic events.
By having a variety of investments, the risk of significant loss is lowered because the poor performance of one investment may be offset by the better performance of others.
In terms of risk management, diversification helps in the following ways:
Reduces exposure to individual asset risk:
If you only invest in one type of asset, such as stocks from one company or one sector, a problem with that particular asset can lead to large losses. Diversifying helps spread out this risk.
Balances returns:
Different assets perform well under different market conditions. By diversifying, you can potentially earn more stable returns over time because some investments may do well while others under-perform.
Protects against market volatility:
Diversification reduces the impact of market fluctuations because some investments may hold their value or appreciate when others are declining.
Minimizes the risk of catastrophic loss: By holding a broad mix of assets, it is less likely that all of them will perform poorly at the same time, which helps protect against major financial losses.
In short, diversification lowers the overall risk of a portfolio, helping investors manage volatility and improve the stability of returns.
Related Articles
What is diversification, and how does it help in risk management?
Diversification is a strategy used to spread investments across different assets, sectors, or geographical areas to reduce the overall risk of a portfolio. The idea is that different assets often react differently to the same economic events. By ...
What is diversification, and how does it reduce risk?
Diversification is an investment strategy that involves spreading investments across different asset classes, industries, or stocks to reduce risk. Instead of putting all money into one stock, investors allocate funds across multiple investments to ...
How can I reduce risk in mutual fund investments?
Reducing risk in mutual fund investments, especially in the Indian equity markets, requires a strategic approach that balances return expectations with risk management. Here’s a detailed guide on how to minimize risk in your mutual fund investments ...
What is the risk-return tradeoff in mutual funds?
The risk-return tradeoff is a basic principle in investing — it means that to earn higher returns, you usually need to take higher risks. And if you prefer lower risk, you'll likely have to settle for lower returns. This concept is very important in ...
What are ELSS mutual funds, and how do they help in tax savings?
Equity Linked Savings Schemes (ELSS) are a type of mutual fund that primarily invests in equity and equity-related instruments. ELSS funds are one of the few types of mutual funds that offer tax benefits under Section 80C of the Income Tax Act, 1961. ...