Why is portfolio diversification essential for investors?

Diversification of portfolio is a method use to minimize risk factor in investments. It takes grouping of various types of investments in a single portfolio, which creates a balance of return throughout the fiscal year. Usually it is practiced by very large financial institutions like Hedge Funds, but small investors also take part in portfolio diversification by investing in for example Mutual Funds. Normally there three types of portfolio diversification. They are:

1. Investment in different types of commodities like shares, mutual funds, government bonds and foreign exchange.

2. Investment within a single commodity but with different strategies, like taking a long position in US dollar and sterling pair at the same time going short with Japanese Yen and US dollar pair.

3. Spreading your investments in different geographic locations. It can help you create a balance in your investments, for example if NYSE Dow Jones is showing a bearish trend there is a possibility that BSE SENSEX is going bullish. It can also apply to investment in entirely different industries.

However, it should be clear at this point that by diversifying your portfolio, you ultimately reduce the potential of high returns on individual investments. But what is more essential for investor is the smooth running of their portfolio, which makes sure sustainability, steady growth and reduced risk.

There are some strategies which portfolio managers apply on their investments to create diversification and maximum returns in both falling and rising market condition, they are:

1. Allocation of assets according to various market trends. A rising trend is also an opportunity for going short in opposite commodity.

2. You can use leverage to maximize chances of target return.

3. Research and analysis are vital for making a decision; both fundamental and technical realizations should be incorporated in your strategy.

4. Limit your strategies to a targeted return or risk level. Over concentration and expectation can cause a big loss of opportunity in other investments. You need to look at portfolio analysis on regular basis.

Diversification of portfolio is a method use to minimize risk factor in investments.

Ayaz Haider