Fundamental Concepts of Diversification

Diversification is a technique for reducing investment risk. It is the only way to protect yourself from unsystematic risk, which is the risk associated with a particular company or stock.

The fundamental principle behind this technique is that a portfolio containing different kinds of assets carries lower risk than any other individual investment. There are different ways to diversify your investment portfolio such as:
(i) Buying different types of stocks rather than investing in only one company's stock.
(ii) Buying stocks from different industries. As a general rule, it is always best to hold diversified group of stocks from different industries.
(iii) Diversifying beyond the stock market. Investors can diversify their portfolio in other types of investment like bonds, gold, etc.
(iv) Further diversification through investing in foreign securities. An economic downturn in the UK economy may not affect the international market in the same way.

If you can diversify your investment portfolio properly, you will have a critical advantage over other traders. By diversifying your investment portfolio among bonds, shares and managed funds, you can lower the overall risk to your portfolio and ultimately increase the overall returns.

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