Investors use a diversification strategy to make sure they are invested in multiple, non-related industries or companies.
Even a new investor knows the value of having a diversification strategy, but they may not fully understand the reasons behind it.
A diversification strategy is the best way to know that an investor’s portfolio is not going to be wiped out by one bad corporate decision or industry failure.
It also protects an investor from the occasional bad investment decision, operating on the theory that “nobody’s perfect.” A diversification strategy allows investors to make the occasional risky investment, or to simply be wrong about one stock or financial product. It’s protection against such errors in judgment or performance.
One key to a diversification strategy is to avoid putting all of your investment dollars into one industry, even when you are buying different products that represent that industry. Investment in the auto industry was at one point a good idea, but when things went bad for the automotives, it went bad for all of them.
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Time constraints also affect one’s diversification strategy. If an investor can wait for an investment to pay off, then the stock market works well, as an investor can wait out a significant downturn in the stock and watch it recover. A diversification strategy would then call for an investor to have some short-term gain investments such as money market funds or certificates of deposit, which carry almost no risk but have much smaller returns.
If both short-term and long-term gains are covered in a portfolio, an investor could look to alternative forms of investment, such as real estate, private equity or precious metals as a way to diversify the portfolio. Each of those types of investments carry their specific type of risk.
A financial provider or advisor can make sure an investor has used a diversification strategy that will have a built-in safety in relation to market conditions. It is important that an entire investor’s portfolio would not be affected by one kind of market event.