The benefits of diversification within an investment portfolio

by  — 18 July 2016

Diversification is a risk-management technique that investors follow by combining different asset classes within a single portfolio in order to minimize losses and maximize the average returns.

Benefits of Diversification

Diversification helps to reduce the unanticipated risks within an investment portfolio in such a way that positive performance of certain assets will counteract the negative performance of others. While stocks and bonds are traditional assets used for diversification by experienced traders, you can also consider binary options as your alternate investment to reduce your risks. Binary options are easy to understand for beginners without any market knowledge and can guarantee returns as high as 80 percent of your initial investment. The important benefits of diversifying investment across several vehicles include:

Minimized Risk

When you diversify your investment portfolio, you can reduce the long-term risk associated with loss of any single financial instrument. For instance, if you buy shares of a single company for USD1000 and if the company does not perform well, you might end up selling the shares for a lesser price and incur losses. In order to avoid this risk, you can buy few shares of different companies by analyzing their past market performance. So even if shares of one particular company fall, the other companies might perform well and compensate for your losses. Based on mathematical analysis and studies by various trading experts, if you maintain a well-diversified portfolio of 25 to 30 stocks, you can cost-effectively reduce your risks and gain decent returns. When you build a diversified stock portfolio, you should choose stocks of companies belonging to different domains and market segments.  You should choose stocks from wide-range of companies including small-sized (market cap ranging from USD300 million to USD2 billion), medium-sized (market cap ranging from USD2 billion to USD10 billion) and large-sized (market cap greater than USD10 billion). You can also invest in foreign securities since they will have less impact from fluctuations in the domestic market.

Different kinds of assets will have different return characteristics depending on various factors like inflation, relative valuations, interest rates and economic activity. For instance, bonds are less volatile when compared to stocks and guarantee consistent returns. Hence experienced traders will balance their investment between bonds and stocks and sometimes other assets like ETFs, binary options, commodities and real estate.  Diversification is not a one-time task and you need to constantly keep track of your assets and rebalance whenever required.

Capital Preservation and Higher Profits

Before you diversify your assets, you should determine the target risk level based on your investment goals, tolerance for market fluctuation and time horizon. Once you determine the risk level and investment goals, you can choose a diversified portfolio based on your investment strategy in order to maximize your returns. In order to build a diversified portfolio you should choose from a mixture of assets whose returns move in opposite directions like stocks, commodities, bonds, binary options, mutual funds etc. By choosing assets whose returns have not historically moved in same direction, you can ensure higher profits because if one group of your assets is declining, the other group of assets will be growing in upward direction. Hence diversification helps to achieve long-term growth and safeguard your investment capital from wild fluctuations in the market.

(Image FotoArabia)

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