Portfolio diversification refers to the practice of holding a wide range of investment instruments in the hopes of spreading the risk without sacrificing return. The principle behind portfolio diversification is the same as the one behind the saying, “don’t put all your eggs in one basket.” Investments are risky by nature; in order to mitigate the risks, investors are advised to buy stock in different market sectors, countries, etc. With a diversified portfolio, if technology stocks start to take a nosedive the investor will not lose everything but will take a hit in only one portion of their total investment portfolio.
Portfolio diversification is the best way to address the unsystematic risk in the marketplace. Each company, industry, and sector has unique risks; by holding a wide range of investment products the investor can diversify away these risks and weather the inevitable setbacks in specific companies or industries. Mutual funds are an easy way to create a diversified portfolio without the complexity of picking and choosing investments individually.
Related Terms: Asset Allocation – Dollar Cost Averaging – Common Stocks – Stock Market Newsletter – Value Stocks – Growth Stocks – Large-Cap Stocks