Diversification

Diversification is the investment strategy of spreading money across different investments to reduce risk. Often called "not putting all your eggs in one basket," it's a fundamental principle of sound investing.

Why Diversification Works:

• Different assets perform differently at different times
• Losses in one area can be offset by gains in another
• Reduces portfolio volatility
• Protects against catastrophic losses

Levels of Diversification:

1. Across Asset Classes:

   • Stocks, bonds, real estate, commodities
   • Each responds differently to economic conditions

2. Within Asset Classes:

   • Different sectors (tech, healthcare, finance)
   • Different company sizes (large, mid, small cap)
   • Growth vs. value stocks

3. Geographic Diversification:

   • US, developed international, emerging markets
   • Different economies, currencies, growth rates

4. Time Diversification:

   • Investing over time (dollar-cost averaging)
   • Reduces timing risk

Correlation:

• Correlation of +1: Assets move together perfectly
• Correlation of -1: Assets move opposite
• Correlation of 0: No relationship
• Goal: Combine assets with low or negative correlation

Limits of Diversification:

• Can't eliminate systematic (market) risk
• Over-diversification can reduce returns
• In market crashes, correlations often increase