Diversification: more than one basket
Diversification is splitting investments among different assets and sectors.
This reduces dependence on a single asset. Three companies in the same sector may behave similarly, so the number of holdings alone does not guarantee good diversification. A diversified portfolio can still fall when the market declines.
Three game companies depend on some of the same factors. Combining different sectors changes exposures.
Check whether the three investments you’re interested in are really different from each other.
Investor.gov · Diversification and Asset Allocation ↗Check your understanding
What does diversification do?
- Eliminate all loss
- Reduce dependence on a single asset
- Guarantee more profit
Answer and explanation
Reduce dependence on a single asset. It reduces dependence, but does not eliminate risk.
Are three companies from the same sector necessarily broad diversification?
- Yes
- No
- Only if their names are different
Answer and explanation
No. They may be exposed to the same risks.
Continue learning
Why do prices change? — A market price is formed at the meeting point between buyers and sellers.
Risk: understanding what you can lose — Risk is the possibility that the outcome will be different from expected, including loss.
What is a fund and what is an index? — A fund pools investors’ money and invests it according to a defined policy.