Investment Portfolio Diversification

Investment portfolio diversification is a basic aspect of financial planning wherein an investor makes investments of various types, and acquires securities in various companies instead of investing in just one company. The object of this aspect of financial planning is to reduce or eradicate investment risks, especially those which are not related to the overall unpredictability of the securities market.

These risks, called “unsystematic risks”, are often related to the risk factors specific to a particular company. These company-specific risks include labor strikes, unfavorable technological changes, increased or new competition, and poor company management.

Investment portfolio diversification allows the minimization of unsystematic risks by eliminating one-to-one correlation between risks and opportunities. Once an investment in a particular company turns out to be a failure, one still has investments in other companies to keep his or her financial stability. Thus, an unfavorable strike of economic problems in one company would have little effect on an investor.

By dramatically reducing, or even eliminating, unsystematic risks, what remains for an investor to deal with is only the “systematic risk”. The systematic risk is the overall impact of various factors affecting investment markets such as political, economic and policy risk factors. Examples of these factors are inflation, fluctuations in exchange rate, general economic changes, monetary policies, wars, and taxation.

Investments can come in any of these three basic types: bonds, stocks, and mutual Funds. The riskiest of which are stocks, since the stock holder is the only one who assumes risk; the company does not. Bonds are somewhat protected since it involves essentially lending money to aid a company in its operations, which it agrees to pay back at a particular rate. Risks in mutual funds vary, however, depending on fund-specific factors.