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With the financial markets all the time bouncing up and down, investors have a great need for safety. One of the most popular ways which can prevent the entire portfolio from losing value is the diversification strategy, a term which is well known among investors, traders, analysts and portfolio managers.
Diversification in its most general sense is the risk reduction in portfolio through smart asset allocation. The well known phrase which always comes with this term is “Don’t put all your eggs in one basket”. Though the latter theoretically covers the main message of diversification, it does not provide practical implication of what role the diversification plays in portfolio investment and how to create a diversified portfolio.
Portfolio diversification is a risk management technique whose main objective is to mix wide range of investments within a portfolio. The rationale on which this technique is based asserts that a portfolio consisting of different kinds of investments will bring higher returns and face lower risk than any single investment in the portfolio.
Allocating assets smartly lowers unsystematic risk in a portfolio so that the positive performance of some investments will neutralize the negative performance of others and keep balance. Therefore, diversifying through unrelated assets which are not closely correlated will be more beneficial.
To ensure that you have a well diversified portfolio you should take into account certain things while creating your portfolio.
While most investment professionals accept that diversification strategy does not completely guarantee against losses they meanwhile accept it as the most essential component in reaching long-range investment goals with minimal risk exposure.