Why Diversification Is Important In Investment?
The main enemy, the obstacle that every investor wants to avoid, is risk. Yet risk is part of every investor’s life. It is the probability that something could have an opposite and negative result than expected. The risk is not always the same, as it depends on many factors, but there are three groups to classify it: high, moderate and low. In each of these cases, and to fight and get out of these adverse situations, the diversification of investments is presented as one of the most interesting and effective strategies.
The concept of diversification in investment/finance
The diversification of a portfolio is an investment technique which consists of composing the portfolio with different types of assets with the main aim of reducing the natural risks of the investment.
Theoretically, diversifying means not placing all the eggs in the same basket in the hope that in the event of a fall, we do not lose everything.
In other words, when we talk about the diversification of a portfolio in finance, we mean the constitution of a base of financial assets comprising assets of different kinds, origins and sectors. In this way, with the help of investment consulting firms in Delhi, we can maintain our profitability with less exposure to risk.
Suppose we invest all of our money in a single security, for example in the shares of a large company, it is likely that in an unfavourable situation we could lose all our money, or a good part of it in case these investments would be considered to have failed. Investors therefore try to protect themselves against this type of risk by widening the range of sectors and assets in which they can deposit their money.
One of the best ways to diversify a portfolio is to have assets with varying degrees of liquidity, risk, complexity, and temporary duration. In this way, we make sure that if one of our options falls, it can be compensated by investments in other sectors.
Portfolios are exposed to two main types of risk:
Systematic risk: this is the risk that affects all assets equally and regardless of their category, because they are external factors and therefore, even if we diversify our portfolio, we will not succeed in eliminating them. These are risks such as political instability, the jurisdiction of each country, natural factors, etc.
Specific risk: the risk inherent in each asset, for example currency speculation, stock market crashes, etc. This risk, unlike the previous one, can be reduced through appropriate portfolio diversification.
To conclude, diversification of investments is a way to protect yourself and avoid risks. Before deciding if this is the strategy you are going to follow, we recommend that you analyse your situation with an expert. Together, you can determine your starting point, your goals, and the level of profitability you want to achieve as well as establish a risk profile, taking into account relevant factors such as age, level of liquidity or your job. A leading financial service company in India, like RKFS, can recommend the instruments best suited to your profile.