Diversification is a technique of managing portfolio. Investing into multiple various assets helps to reduce risk and ensure more balanced performance.
Positive results of good investments weaken the negative effect of worse. This way, not predicted and extremely poor performance of some investments can be reduced. Of course, such diversified portfolio’s rate of return would be lower that rate of return of your best performing asset.
Diversification can and should be done on different levels:
- type of investments (stocks, funds, bonds),
- risk level,
- type of industry/market,
- time.
For most beneficial results, it is important to keep relatively uncorrelated assets.
photo credit: eurok
Fortunately, I learnt about diversification at the very beginning of my journey into world of investing. As my knowledge about stock market was close to zero, I started with putting my money into different funds. These funds were already diversified among various types of investments, but I had a feeling that I don’t want to invest all my money only into one. As far as I remember, I chose five, best performing. It was about 2 years ago and results provided by such funds in Poland were pretty impressive. Stock market was going up, so the diversification wasn’t so important in that case, but it was a good time to develop it as a habit.
These good times on market couldn’t last forever. About summer 2007 funds were giving worse and worse results. I started thinking about changing my investing strategy. Meantime, I was of course learning some basics of investing in stocks; especially I was focusing on technical analysis.
Finally, I had no doubts, that I should quit funds as they were only slowly sucking my money. Somehow I forgot about diversification at all. I started picking single stocks and hoping for the best. I was so stupid.
It is not possible to pick only well performing stocks. Failures happen. We have to accept it. We cannot expect to earn on each investment.
Good for me, I pretty quickly learn from my mistakes. After a few poor picks where I lost few hundreds of zlotych (1$ is about 2,5zl), I had a stroke of genius. Diversification. I must diversify.
I started opening multiple positions on stocks from different types of industry. Few of my shots missed, but this loss was covered by good picks. Brilliant. Rate of return wasn’t too high, but it was my very beginning of investing in stocks. When you gain more knowledge and experience, you start to pick better and better stocks more often, and less time you open poor performing positions. But no matter how good investor you are, diversification is very important technique.
As you can see on my case, it worked in the past when I was focused on funds and it works right now, when I invest in stocks.
If you are concerned, I also diversify by type of investments keeping some money on my saving accounts and from time to time, I invest in other types of assets.
Remember; don’t put all eggs into one basket.
