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Diversifying Your Portfolio: Is There Really A Need To?

Sep 17, 2008
When it comes to financial management, diversification is one way of earning a better and steadier keep. It is a type of risk management technique that entails investing on several securities all at once, as opposed to staking speculations on only one or two securities. This is considered somewhat as risky move; and yet, since there are many securities to take account of, any fluctuation between the said securities is hardly felt by the broker, investor, or trader.

In simple terms, a portfolio is this particular mix of investment by any client whether that client is a private individual or a larger business entity like a corporation or institution. As a rule, portfolios could include assets and trading in securities like: bonds, cash, future contracts, gold certificates, mutual funds, options, production facilities, real estate, stocks, and warrants.

Why trade with diverse assets? Why not stick to one?

Having diverse assets actually helps the investor gain decent ROIs or return of investments, no matter what the outcome of all trading in all concerned markets happens to be. If one asset does poorly in the market, this can be overshadowed by the other assets doing fairly well on the trading floor.

Admittedly, it would be a lot easier to maintain trading in one type of security only. You only have to follow up on one kind of market and can monitor its progress religiously. If you choose such trading technique, you have more liberty to predict the possible trading pattern and make your bid whenever you think you have the most to gain. However, not all predictions can yield positive results, and when all things fail, you may be losing a lot more money with no other alternatives to rely on.

Diversifying your portfolio means that:

Yes, you will have more trading markets to monitor and that will not come easily. Yes, unless you hire a broker for each asset you are trading with, it would be very difficult to predict market movement to your advantage. However, if one asset fails to earn profits in the trading floor, you can rely on your other assets to either: gain you profits, or at the very least, help you break even.

To make this explanation more graphic, let us cite a very concrete example.

Let us suppose that there are two farmers with large tracks of land. Farmer John invests all his land to wheat planting. Whereas, Farmer Lee invests only half of his land to wheat, while he plants other cereal crops like barley, buckwheat, oats and rye. On a very good harvest season, wheat prices soar. Naturally, Farmer John rakes in a lot more profit than Farmer Lee, since the latter has more wheat to sell.

However, on a very bad harvest season, when the supply for wheat is far greater than the demand, prices may drop dramatically. This is not a very good sign for Farmer John who may have to sell his crops at the lowest possible market rate, and still not break even.

Farmer Lee, on the other hand, may up his prices on barley, buckwheat, oats and rye. In fact, he might just increase his prices to a level that his loss over the wheat trade is hardly noticeable compared to his other cereal grain sales.

As for the financial market, this means that the investor with a diverse portfolio has more chances of acquiring decent profits even in the worst trading season yet.
About the Author
Justin DeMerchant is the founder of metastock, nyse stock trading , and stock beta calculation where information on stocks and investing can be found.
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