Why diversification is so important for investors
Diversification is an important strategic principle in investment. Intelligent diversification can reduce the risk of loss and increase the chances of profit.
What does diversification mean?
Diversification is an economical strategy. The term is derived from the Latin word diversus, which means as much as different. In diversification, products, services, business areas or even investment classes broadly based in order to spread and thus reduce the risk of default.
What exactly is diversification?
Diversification in the financial sector means risk diversification. Diversification is based on the motto: you shouldn't put all your eggs in one basket. If the basket falls down, many - possibly even all - eggs are broken. The risk for the eggs is therefore very high. However, if all the eggs are spread over different baskets, the loss is much less if one of the baskets falls to the ground.
What does diversification mean in terms of investment?
Diversification plays an important role by structuring investment portfolios. When money is invested, the aim is usually to generate a return. Depending on the type of investment, there is always the risk of losing some of the money, for example through falling share prices. With some financial products, a total loss is even possible - for example, if a company is insolvent. To reduce the risk of loss, money should therefore never be invested in a single product, but in many different ones.
Anyone who wants to invest money should try to assess in advance their risk tolerance. Risk and return are closely related: riskier investments can bring a higher return, but usually also have a higher risk of loss. Secure investments, on the other hand, have a lower risk of loss, but also a lower return. Through targeted diversification, different classes of risk can be combined with each other in such a way that it corresponds to your personal risk tolerance and return expectations. Diversification therefore serves not only to spread risk, but also to increase the chances of profit.
How can investments be diversified?
There are various ways to diversify an investment. The following options are best considered when putting together a portfolio.
Different financial products within an asset class: If, for example, shares are bought, you should never bet on just one company. It makes more sense to buy shares of different companies or to invest directly in a broadly diversified equity fund. If you want to invest in real estate or tangible assets, it is best to invest in many different ones. Crowdinvesting is very well suited for this.
Various asset classes: Equities can be very volatile. In the event of a crash, the whole market can go on a downward slide for a long time. It therefore makes sense to include more stable asset classes in the portfolio - such as real estate investments, bonds or tangible assets.
Different sectors: Future industries are in vogue and many people have favourite industries to which they feel particularly close. But what if a particular industry is affected by a crisis? A good diversified portfolio should therefore always be structured across several sectors.
Different regions: Many investors tend to invest only in for example companies located in the home country. This can be useful, after all we know our own financial products and can rely on the corresponding laws. But in order not to be dependent on the situation of the home countries economy, a geographical expansion of investments is advisable - for example to the whole of Europe and additionally also America or China.
The basic idea of diversification is therefore that money is spread over several different financial products that complement each other in a meaningful way in order to minimize risks. If an asset class goes wrong, it is still possible that other investments will not be affected and, if necessary, compensate for part of the losses.