PORTFOLIO TALKS: DIVERSIFICATION VS. CONCENTRATION
A usual advice given to someone with regards to managing his assets is to diversify it, emphasizing its ability to reduce risks. However, this does not work well at all times, because while this may offset your losses, it can potentially lessen your gains as well. Since every investor is aiming for higher than average returns, it would be wise to look back on this principle and clarify when it is applicable. First off, here are the many ways one can broaden the variety of their holdings:
- Possession of stocks from more than one company or industry
- Investment in several market sectors
- Owning stocks with different capitalization ranges
- Global investing
- Venturing from various asset classes
- Trying on numerous trading strategies
Given these many method, the main question lies on the extent you wish to diversify your portfolio. This should be driven by your personal goals, risk tolerance, and choice of styles. It is also crucial to be familiar about the pros and cons of your every choice.
Diversification advantage Like earlier mentioned, it reduces volatility level and possible risks. In case some of your investments decline, you can count on your other holdings for balance and soften the blow of your losses. It also provides you with extra profit opportunities. For example, going for foreign stocks may be a big gain for you, given that this certain country’s economy booms.
Too much variation? An exceedingly diverse portfolio has its own share of troubles as well, although they are not highly publicized. For one, aside from trimming down your potential gains, it has a tendency to give you only average returns. It can also drag your profit, if majority of your assets are in a downturn and only a handful are performing well. Another issue here is the large amount of transaction costs for maintenance. You may also have a hard time keeping track of your assets, or at times, be compelled to plunge into an investment you barely know, just to support your aim for diversity.
Benefits of concentrated portfolios While it is true that focusing one one sector alone increases your risks and may cause a massive dent during a downfall, it can also give you huge sums of returns. Most of those who generate high profit are not from the well-diversified ones, but on those whose attention is centered on a single industry or or class. It also allows more efficient management that will pave way for quality investments.
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