Your stock market portfolio and diversification

It is quite a long word, diversification, but it is important to fully consider it when setting up a stock market profile, and understand the reason why it is recommended.

That reason is simple, and it is to do with risk. Whenever you invest in the stock market there is a big capital risk: that of potentially losing all your money, as stocks can go up and down, fall as well as plummet.

Now let's look at a very simple example: if you have Łx to invest and you split it across one company, then all your eggs are in one basket. If you split it five ways, so Łx/5 in five different companies, then now you have the situation where all five of those companies going bust (worst case) is infinitesimally smaller than just one going bust, and therefore you have diversified, you have spread the risk.

And of course if those five companies are across different sectors then you will have diversified more than having them all in one sector, as the stocks in a sector often tend to follow the same trend: for instance how often have you seen that bad news at one bank has dragged down the price of the other banks that day, and also the flip side where great results for one have led to more confidence in the sector as a whole and therefore reflected positively on the other shares in the sector.

So by diversifying in different sectors as well as different stocks, you will help to spread that risk too.

And whilst this article is about stock market diversificaton remember that the best diversification is also to have different types of asset too, for instance commodities, bonds, cash and perhaps property.

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Tools and Resources

Your stock market portfolio and diversification

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