Diversification

Diversification                     

Diversification begins with a very beautiful quote.

“Don’t put all your eggs in one basket”.

The idea behind this is to diversify risk across a number of assets or investments.

So the main benefit of diversification is in the form of risk reduction.

To better grip the diversification, we must have knowledge of risks associated with investments.

So broadly, there are two types of risks.

·       Systematic Risk

·       Unsystematic Risk

Systematic Risk

It is the variability of return on portfolios associated with changes in return on the market as a whole.

Systematic Risk is due to risk factors that affect the overall market such as changes in the nation’s economy, changes in the world energy situation or a change in government policy. These are the risks that cannot be diversified away.

Unsystematic Risk

It is the variability of return on portfolios not explained by general market movements. It is avoidable through diversification.

Unsystematic risk is unique to a particular company or industry so it is independent of economic, political, and other factors that affect investments.

Unsystematic risk accounts for around 50 percent of the stock’s total risk.

So Total Risk = Systematic risk + Unsystematic risk