What is Diversification?
Diversification refers to the investment done by a businessman in a variety of sectors and industries in order to diminish the risk of cash volatility in the stock market. Many stock professionals know that diversification can’t be termed as the guaranteed savior from the loss. However, diversification can save you from prodigious losses. Several companies and sector waver back and forth but this is not done at the same time. In simpler words, when one company or a sector is flourishing, there may be another sector which is facing the downfall. Hence, it can prove to be a boon for the business.
Do Not Over Diversify
There are several people who met with the tragedy of total loss. The major reason for this is to over-diversify your portfolio. When you diversify your portfolio beyond your limits, there may come sometimes when there is cost volatility and the risks of getting total loss may occur. There a lot of detrimental consequences of over-diversifying.
- Neglecting one’s own business:
When you invest in a lot of industries or companies, it is very much likely that one may neglect its own business. There is not much time to take notice of every little change that has been going around in each investment. Thus, it is highly recommended to diversify your portfolio within your capable reach.
- Dilution of Best Ideas:
When you have a number of industries and stocks to cover, your best ideas may get diluted in the swarm of investments. Therefore, if you try on something to increase the welfare, there are a lot of chances that instead of giving major monetary results, you may only meet with marginal impact on the entire rate of the portfolio.
- Tones down the Stock Ethics:
Stuck in between a variety of investments can lead you to tone down your investment standards. If you have a plenty of options to choose from, you may not pick up the best shot vigilantly and wisely. Diversifying the portfolio requires a critical and wise approach. This is fabulously summed up Warren Buffet who is a billionaire investor. He wanted to make people comprehend the true meaning of diversification. He summed it up by giving a short example. He used to say to the investors that imagine if they won a punch card but having a few slots only, say, a twenty. After the usage of each one of the slot, there won’t be any more for investing and you would have to live with it through the rest of your lives. Warren Buffet explained that selectivity is the key to gain maximum benefits in the investment tribe. Therefore, over-diversification is totally out of the box.
The Bottom Line
Diversification can be referred to as the cup of ice cream. It seems good, but only in a certain amount. Excess of everything is bad. Therefore, you must not overstep the mark by diversifying your portfolio. If you’re looking forward to taking lesser risks, then you should invest in the large, profitable companies. The investment shouldn’t be more than 20%.
Then there come small and precarious companies. The benefit of these small industries is that they show a tremendous success but it can also prove to be the total loss with zero refund. It is wise to invest not more than 5% in such companies. In the end, it’s all about well-balanced diversified portfolio.