What is Diversification And How It Works

What Is Diversification?

In Finance there are two common techniques, used for reducing the risk in Investment, Diversification and Hedging. Diversification is a strategy(an asset allocation plan) to minimize the risk by making a portfolio with various types of investments. A diversified portfolio can be created by allocating the capital in different categories of Investment(variety of companies, asset classes, industries etc.). A diversified portfolio gives higher long term returns by averaging the returns from different types of Investments and reduces the all over risks.
How diversification works
Investing only in one asset class or industry is not a smart Investing. You may earn more returns but at same time your entire portfolio can be affected by a single negative event in that industry or class. You have many investment in your portfolio, each with its own advantages and disadvantages, responding differently to the market fluctuations. If you have a diversified portfolio than some of your Investment may low performer or some may high performer, so the diversification can eliminate the risks from low performing assets and makes a reasonable return.

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