Diversification

Diversification is a method of portfolio management where a business owner or investor reduces the unpredictability or risks of their investment or portfolio by investing in a variety of different investments that have little correlation with each other.

Diversification is a method of portfolio management where a business owner or investor reduces the unpredictability or risks of their investment or portfolio by investing in a variety of different investments that have little correlation with each other. This is a process that reduces risks by allocating investments among various financial instruments, industries, and sources.

It is important that investors don't "put all their eggs in one basket." This helps to reduce the risks and pitfalls should in case one of his investments was a bad decision, and it didn't go well. Another way to reduce risks is to include bonds and cash. Remember, no matter how diversified your portfolio is, you can never eliminate risks completely.

The main idea of diversification is that, the successes and good performances of some investments or portfolio balances or even outweighs the negative performance of other investments and portfolio that might not be doing too well.

Let's take an example. An investor has about N5 million to invest to invest in healthcare. He decides to divide the money into four halves and invest the monies in four different portfolios, say he invests in stocks for one, beverages and wines, technology and ICT and then healthcare. 

He expects all to perform very well and earn him some revenue, but then, the unpredictability and risks involved in business come along, crashing the prices of stocks and healthcare. However, ICT and technology experience a boom and an almost doubled return in his capital, and beverages and wine perform on the average. You find out that although he may have lost quite some money in the investments he made in healthcare and stocks, the returns he made from ICT and technology has covered his capital and investment clause.

That’s just how important diversification is to investors and business owners. The big catch in diversification is that to do it well, the securities in each portfolio that may have been invested in need not to move together. That is the less correlated they are, the better, and that’s exactly what the investor above did, he invested in several securities that even if he suffered from one, the others he invested in didn’t necessarily affect the other.

This is one of the reasons why many investors go a step further to diversify across different asset classes. We know that bonds, stocks, and real estate are common examples of asset classes, so, one major move investors do is to invest in both stocks and bonds because they are negatively correlated. Hence, when the bonds market is down, the stock market is up and booming and vice versa. 

All these are ways in which diversification can be involved in business and the market as a whole.