Diversified Investments

Diversified investments refer to a low-risk investment plan that works as the best defense against a financial crisis. These allow an investor to earn the highest possible returns by making investments in combination with a combination of assets like stocks and commodities, fixed income, mutual funds, cryptocurrency, cash and cash equivalents, etc.

The diversification strategy for investing in diversified assets mixes various investments for constructing a portfolio. Holdings in a portfolio can be diversified in several ways, and they can be diversified based on asset classes, industry-wise, company-wise, and geographically.

• A diversified investment portfolio is a low-risk investment strategy that is the most robust defense against a financial disaster. It enables an investor to get the maximum potential returns by investing in various assets such as equities and commodities, fixed income, etc.
• Different asset classes, individual companies, industries, and geographical dimensions are the diversified investment types.
• Diversifying your investment portfolio can lower the chances of losing money. For example, when one investment underperforms, other assets in the portfolio can perform better, reducing the overall risk of loss than investing all the capital in one type of investment.

Diversified investments are a mixture of different assets like stocks, fixed-income securities, and commodities to achieve the highest return for the minimum level of risk. The diversification concept works because all the have different reactions concerning the same event happening in the economy.

Diversification limits the overall risk of the portfolio risk but, at the same time, also mitigates the performance of the portfolio, at least if invested in the short term.

All the assets in the diversified investments do not correlate with each other, and generally, when the value of some investment falls, then at the same the value of another type of asset may rise. Due to this, the overall risk of total investments becomes low as in case of any event; there are some classes of assets that will give benefits and offsets the loss incurred in other assets because it is rare that all the classes of assets would have a negative effect by any one event.

Diversified investments help investors achieve a smoother and more consistent return on the investments over the long and medium-term period. When the person's holdings are diversified widely in divergent types of assets such as stocks, bonds, commodities, real estate, and cash, it helps reduce the portfolio's overall risk as each asset class exhibits different types of strengths and strengths and weaknesses concerning risk and profitability.

So, maintaining holdings by a person in the majority of these asset classes helps him create a stable portfolio, which then helps increase value over the period.

There are diversified investment advisors who help amateur investors to understand the concept and its complexities well, which ultimately helps them make better and more effective investment decisions.

As diversified investments offer a variety of options for investors to invest in, it is important to have a look at those options in detail. There are different ways through which investments can be diversified, some of which are as follows:

#1 - Different Asset Classes

Different types of classes of assets have different performances during the same economic event. So, different classes of assets such as stocks, fixed-income investments, commodities, real estate, cash, etc. can be included in a portfolio for diversified investment resulting in lowering the overall risk.

#2 - Different Individual Companies

Different individual companies perform differently in the market according to the different factors. So there should be a mix of such companies to reduce the portfolio's overall risk.

#3 - Different Industry

The portfolio should have balance across multiple industries in the economy as some events are industry-specific. If that event occurs, the only value of investments in those industry instruments will only decrease. So, one should invest in different industries so that a portfolio's overall risk is low.

#4 - Different Geographical Dimensions

Most investors have biases towards instruments issued in their home country. But it is always beneficial to diversify the portfolio internationally because an event that is negative for one country might have no effect on other countries or might have a positive effect on other countries. So if the investment is diversified geographically, then a loss in investment in one country can be offset by international investments.

The main functions of the diversified investments are as follows:

• Such options help investors maintain diverse portfolios at the same time. They get different classes of financial instruments to spend on for better returns. Likewise, it gives them an opportunity to assess the market well and understand its different aspects. The deeper they delve into the market, the more they learn about how it works.
• These investments allow investors to spread risks. When there are multiple assets to invest in, people get a chance to spread risks and profits and have a balanced profile. For example, if an investor incurs a loss in investment A, the profit in investment B and C helps them bear the loss smoothly.

Let us consider the following examples to understand the concept better:

Example 1

Let’s say the volatility in the share market increases, and then, in that case, there are chances that the people who have invested in stocks incur a huge loss. In such cases, if a person is holding investments in some other class of assets as well like fixed interest investments or direct property, which do not have an impact on the same event during the same period, then the return generated out of these investments will help in reducing the overall risk of the portfolio and smoothing the overall returns.

Example 2

Recently, Asia Cement rewarded its shareholders with lucrative dividends for the 61^st year in a row. It accepted how diversified investments have helped it maintain a balance between profit and loss without having to struggle to bear the latter. It still aims to leverage the benefits of diversification using innovative technology and other measures.

Diversified investments help investors invest in a myriad of options together and check the market fluctuation from time to time. This way, they gather more knowledge on how the market works, and hence, they become a more mature market participant with time.

Below are some advantages of Diversified Investments.

1. The diversified investments help in minimizing the risk of loss because if one investment doesn’t perform well over a particular period, then other investments in the portfolio may perform better in that same period helping in reducing potential losses associated with the investment portfolio if all the capital is invested under a similar type of investment.
2. Sometimes the investments might not generate the returns as expected, so in that case, the diversified investment helps because through diversification, one is not merely relying on one source for generating the income, and he is investing in diversified investments.
3. When the investments are well diversified, lower maintenance will be required because care and attention are required to keep the investments performing well, and if there is a risky venture, then a huge amount of time will be required to watch the markets. A well-diversified portfolio is generally more stable and less exciting, so once they are settled into a variety of classes, they can be there for extended periods and do not require much maintenance.

Though there are multiple advantages to having a diversified portfolio, the process does have some disadvantages as well. Investors, before choosing this option, must know the limitations that it has.

The following are the disadvantages of Diversified Investments.

1. If the investments are diversified, the same could only generate average returns. This waters down the profits and makes the portfolio look less than great. In case one holds one security that suddenly spikes, he can earn a good amount of profits that cannot be there in the case of diversified investments.
2. Additional transaction costs are also associated with diversified portfolios because one has to pay more to balance the portfolio to maintain diversification.
3. When there are various assets in the portfolio, it is generally more difficult for a person to manage it as there would be too many investments in a portfolio. If only one security in which investment is made, then it would be easier to manage the same.
4. Sometimes, the portfolio's overall diversification risk increases because the diversified investment person might invest in a security of which he has little knowledge or doesn't have any knowledge. One should always perform due diligence before investing.

This has been a guide to what are Diversified Investments. Here, we explain its functions, types, examples, advantages, and disadvantages. You can learn more about Portfolio Management from the following articles –

• What are High Risk Investments?
• Formula of Portfolio Return
• Calculate Portfolio Standard Deviation
• Portfolio Management Career Options