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What is diversification, and why is it important?
Wealth Management
October 6, 2022

What is diversification, and why is it important?

Many professional investors talk about the important role of diversification in reaching long-term financial goals. But why is diversification so important, and how does it help protect your investments from significant market fluctuations?

Key Takeaways

  • With diversification, investors aim to minimize risk by spreading investments across different asset classes.
  • The more diverse investments your portfolio holds, the more resilient you are to varying risks.
  • Achieving a balanced, diverse portfolio can be complicated but not impossible.
  • Diversification when done smartly can reduce risk and improve returns and results.

If you want to learn more about diversification, you’ve come to the right place. In this post, we’re going to talk about what diversification is and why it’s an important step to take when developing your portfolio.

What is diversification in investing?

Diversification is an investing technique that helps reduce risk by spreading your investments among various financial industries and instruments (assets). The aim is to minimize losses in different areas as each asset class reacts differently to the same event. 

While diversification doesn't guarantee full protection against loss, it does help reduce the risk and keep you on track to reach your financial goals. Think of diversification as "not putting all your eggs in one basket." Diversification means investing in more baskets. By doing so, if an investment loses value, it won't break all your eggs. Every financial instrument has its own risk factors; it's something you cannot avoid. Bu investing in a single instrument makes you more susceptible to specific risk factors, making it challenging to develop reliable profit expectations. 

These risk factors can include the following:

  • Market risk: How the fluctuations within the market affect your returns.
  • Geographical risk: How political changes affect the equities of a particular market. For example, most recently, the Russian stock market collapsed.
  • Interest rate risk: How interest rates affect your yields and returns.
  • Idiosyncratic risk: How specific changes within the company affect its stock return.

The more spread out your investments are across various industries and markets, the more resilient your investments are to the above risks. While achieving a balanced, diverse portfolio is complicated, automated trading tools like BOTS can help diversify your portfolio without much hassle. With BOTS Gold, you can even get personal assistance when you invest more than €10,000.

Why is diversification important?

While you know what diversification is, is it that important? The short answer is yes. But let’s talk about it in a little more detail. 

Helps protect against losses

No one wants to lose money while investing; that’s not what investors are doing this for. Diversification can help protect against losses by spreading investments through varying instruments and markets. For example, older investors may rely on their portfolios to cover living expenses. That said, diversification can help reduce the potential risks listed above. Additionally, diversification is often used as method for hedging against inflation.

Recommended: How To Hedge Against Inflation?

Improve your returns and results

Diversification has many benefits for you as an investor, with the largest one being that it can improve your returns and stabilize your results. Investors earn greater returns when you factor in the risks they’re taking. 

When owning different assets that are all performing differently, you reduce your portfolio risk so no single investment can significantly hurt you. For example, you can invest in high-risk stocks that'll bounce up and down while your CDs steadily grow.

Creates better opportunities

While many investors diversify to protect their investments, diversification also helps to create more opportunities. How? Let's say you invest in Netflix to diversify from transportation companies. Then, Netflix announces a huge partnership. You wouldn't have benefited from this positive change if you didn't diversify.

Makes investing more exciting

Investing is fun as it is, but with diversifying, you’re entering new industries and buying into different industries. If you’re investing in a small group, you’re not stepping out of your comfort zone and exploring other opportunities available.

Diversification, while not a requirement, is something you should strongly consider when investing. Diversifying your investments will help you minimize losses, improve returns and results, and open doors for possible opportunities. BOTS can help you diversify your portfolio without the added hassle and help you reach your financial goals. Find out more about how the BOTS app works!

Disclaimer:

This blog is for educational purposes only. The information we offer does not constitute investment advice. Please always do your own research before investing. 

Any views expressed in this blog and by BOTS do not constitute a recommendation that any particular cryptocurrency (or cryptocurrency token/asset/index), portfolio of cryptocurrencies, transaction, or investment strategy is suitable for any specific person.

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