Groups portfolio of cross-platform. Financial diversification
Published September 21st, 2007 in Uncategorized
Diversification is a risk management technique that mixes a wide variety of investments within a portfolio in order to minimize the impact that any one security will have on the overall performance of the portfolio. Diversification lowers the risk of your portfolio. Academics have complex formulas to demonstrate how this works, but we can explain it clearly with an example:
Suppose that you live on an island where the entire economy consists of only two companies: one sells umbrellas while the other sells sunscreen. If you invest your entire portfolio in the company that sells umbrellas, you’ll have strong performance during the rainy season, but poor performance when it’s sunny outside. The reverse occurs with the sunscreen company, the alternative investment; your portfolio will be high performance when the sun is out, but it will tank when the clouds roll in. Chances are you’d rather have constant, steady returns. The solution is to invest 50% in one company and 50% in the other. Because you have diversified your portfolio, you will get decent performance year round instead of having either excellent or terrible performance depending on the season.
There are three main practices that can help you ensure the best diversification:
1. Spread your portfolio among multiple investment vehicles such as cash, stocks, bonds, mutual funds and perhaps even some real estate.
2. Vary the risk in your securities. You’re not restricted to choosing only blue chip stocks. In fact, it would be wise to pick investments with varied risk levels; this will ensure that large losses are offset by other areas.
3. Vary your securities by industry. This will minimize the impact of industry-specific risks.
Foreign exchange diversification is using say currency A and B that have an inverse relationship. Therefore, if you have 100 US$ and you invest 50 US$ in Currency A and 50 $ in Currency B. Your currency risk is hedged to a great extent. Internationally financial diversification for currencies is practiced in form of basket of currencies. In case of IMF, a SDR (Special drawing Rights) is used
made up of USD, JPY, Euro and British pound (there may have been changes in currency holding).
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