Today we will understand how diversification works.
Diversification is an investment strategy to lower the risk factor on the markets and the global economy. You must always remember that the stocks or bonds you buy on the market are issued by companies that work, produce, take risks and make mistakes.
Only those who do nothing are never wrong o never make mistakes.
These risks and errors can be of various kinds, from the administrative level to company management or they can change situations or laws that outline the correct policies regarding companies in a given territory. Many of these issues are visible with a long-term view, but very often it happens that problems suddenly fall out of the sky.
So a common sense strategy might be not to put all your eggs in one basket, but to have your money invested in various companies, so that an attack on one company doesn’t cause you to lose all your money.
This is to reduce the risk of the portfolio.
This kind of strategy works best only when your asset position arent correlated, that it means that a financial asset is affected to rise or fall in price, due to the rise or rise in the price of another financial asset. To take an example, think of the value of gold and the value of mining shares, or of oil and the shares of oil companies.
If you want to understand if your investments are uncorrelated, look for some tools on the internet that can help you.
A good general way to diversify is to invest in different industries in different sectors.
Given that each sector encounters different and unique risks. The same goes for when we think about different countries or continent. Different countries have different risks and problems
Globalization has helped us with the possibility of investing our money in different countries of the world, but this has meant that the correlation between the various companies even from different continents increased, just think of how Western companies are only linked to the supply of raw materials and semi-finished products from Asia.
Diversifying is not a quick and easy strategy, quite the opposite. We need to spend a lot of time studying the various issues and then studying the various companies that may interest us. Creating a risk-free portfolio is nearly impossible but doable.
We will then have to be careful about the costs of creating the portfolio given the amount of positions we could open.
ETFs are a good choice, but that’s your job. Study and choose the best for you and your family’s financial life. Remember not to run into a false diversification by buying different assets but which then have the same underlying.
Always remember that your goal is to safeguard the account, avoid large drops in its value and limit volatility by controlling risk.