When it comes to investments, there are many things to consider. Even if you hire a professional to help you with your investments, it is important that you understand them and how they work. The more you know, the better you can make decisions, whether on your own or with a professional’s help.
One of the main focuses that most investment experts focus on is diversification. Here is everything you need to know about investment diversification.
Diversification Explained
Diversification can be explained very simply with the following sentence, “Do not put all your eggs in one basket.” The saying indicates that if you have all your eggs in one basket and drop it, you will lose all your eggs, whereas if you separate them into several baskets, you will only lose a few if you drop one. The same thing is true when it comes to investing.
Investing can be risky in itself, so if you want to be a savvy investor, you have to look at ways to reduce risk while continuing to invest in ways that will get you the highest possible returns. Diversifying is the best way to accomplish this goal.
So using the eggs in one basket analogy if, instead of eggs, we are talking about money, losing everything can be a setback that will cost you a lot to recover and greatly reduce your profitability. Diversification applies in all areas of investment and also a business.
Consider Fanta, Sprite, Nordic, Aquarius, Powerade, Nestea, Minute Maid, Aquabona, etc. Do you know what they all have in common? All are brands of CocaCola. The company earns a lot of money selling Coke, but they know that this can change since nothing is static. Therefore, they constantly diversify and create and acquire new brands. They do not want to put all their eggs in the same basket, and they prepare for possible changes being in the largest possible number of markets within their industry.
Types of Diversification
There are three major types of diversification, especially when we talk about investments.
Geographic Diversification
Geographic diversification is investing in multiple geographic areas rather than all in one area. This could mean that you could invest in companies that are based in different states. This type of diversification could also mean taking your investments internationally and investing in companies from other countries. Going international can protect some of your investments if a country hits hard economic times or has a stock market crash.
Asset Diversification
Diversification of assets means that you have investments in several companies. To diversify even more, you could make sure your investments were in different industries: the more diverse, the better you are protected, and the lower the risk for the higher returns.
Temporary Diversification
Temporary diversification means that you buy several stocks for a short time with a quick turn around to sell. This investing can give you some capital to put towards longer-term investments.
Final Thoughts About Diversification
Diversification refers to the allocation of funds or investment in different assets. Another great analogy of what diversification does for the investor is the window analogy. If you have a window that is one pane of glass if that window gets broken, you will lose the entire pane of glass, and the cost to replace it will be high. However, if you have a window that is nine panes of glass, if one of the panes gets broken, the other panes are still protecting from the elements, and the cost of the one small pane is far less of a hit on your income.
The idea behind diversification is that you can take more risks in some of your investments because you have several investments working for you. You can also afford to invest in areas or industries you might not try because of the risks.
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