Diversification

Diversification

A risk management technique that mixes a wide variety of investments within a portfolio. It is designed to minimize the impact of any one security on overall portfolio performance.

Investopedia Commentary

Diversification is possibly the greatest way to reduce the risk. This is why mutual funds are so popular.

Related Links

A Guide To Portfolio Construction
Achieving Optimal Asset Allocation
Asset Allocation Strategies
The Dangers of Over-Diversification

See also: Asset Allocation, Mutual Fund, Portfolio, Systematic Risk

diversification

The acquisition of a group of assets in which returns on the assets are not directly related over time. An investor seeking diversification for a securities portfolio would purchase securities of firms that are not similarly affected by the same variables. For example, an investor would not want to combine large investment positions in airlines, trucking, and automobile manufacturing because each industry is significantly affected by oil prices and interest rates. Proper investment diversification, requiring a sufficient number of different assets, is intended to reduce the risk inherent in particular securities. Diversification is just as important to companies as it is to investors. See also unsystematic risk.

What types of mutual funds provide the best diversification? Diversification, the notion of not putting all your eggs in one basket, is among the most celebrated concepts in finance. Economist Harry Markowitz even got a Nobel Prize for turning your parents' oft-repeated advice into mathematical equations. Diversification both reduces investment risk and increases the odds that you'll earn a decent return over time. A big attraction of mutual funds is that they offer instant diversification. You own a portfolio holding anywhere from hundreds to thousands of stocks or bonds for an initial investment that can be as low as $100. The best way to make sure that your equity mutual fund is well diversifiedand not just stuffed with the latest high flyersis to own a broad-based equity index fund. The same goes for fixed-income securities through a bond index fund that invests in both corporate and government debt. Although the annual management is higher, an alternative is an actively managed balanced fund that owns large and small companies and value and growth stocks as well as fixed-income securities. Christopher Farrell, Economics Editor, Minnesota Public Radio, heard nationally on Sound Money®