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When Should Investments Be Diversified?
By John | September 3, 2010
It is a common myth that diversification reduces risk and everyone should always diversify their investments. What better testimony to the contrary than Warren Buffet, who has publicly said he never believes in diversification. Though it is true that there exist financial situations, especially for the small and medium investor, where diversification seems to be the best strategy, there are many other situations where diversification can simply ruin a potentially good investment and thus should not be pursued, lest it become a poor investment choice with inadequate returns. Just to invest in a particular asset class to diversify, people tend to remove money from profitable investments or take fast cash loans, both of which give poorer returns on investment. Therefore one should remember that diversification is not a fool-proof strategy but one needs to analyse the current financial and economic situation to determine the type of diversification that works best.
One should remember that by diversifying, one loses potential profits as risk is reduced. This is the general rule in any investment – lowering risk almost always reduces the earning potential as well. Thus if a person A had invested in Apple shares 10 years ago while person B had diversified into a number of technological stocks, the return on investment for person A would have far exceeded that of person B. Thus if one is planning for a risk free investment strategy, then diversification should be used. If not, one should take up higher risks and invest in solid companies individually.
Another aspect of diversification is across markets. Investors should, however, have a thorough knowledge of the markets they want to diversify into. There are many options for diversification and for those who are looking to add something other than the stocks to their portfolio, commodities market is a great option to consider. The commodities market essentially trades in, as the name suggests, commodities that are important for industrial and individual use. The simplest among these to understand and invest in, especially for the small investor, is the market of precious metals. This includes not only gold and silver, but also platinum, palladium, copper, nickel, tin, etc. However, it is simpler to start with gold and silver because investors tend to know more about these metals than the others. Metals like copper are almost purely industrial metals, which means the price of copper really depends on the industry demand and supply, which needs a little bit of research to invest wisely.
While investors seek to diversify into new markets to improve their profits, it is important to note that they should have adequate means to get the latest news that relates to the new areas which can have bearing on the market behavior. For example, assume that an investor wants to invest in the metal palladium. In this case, he will need to look for the demand and supply for palladium through the various industries that use this metal and are dependent on it. In addition, one should look at the auxiliary industries that also depend on this metal. One should therefore look for financial subscriptions that carry the latest financial news. Many of these services are paid and can be easily covered with the help of fast cash loans.
Topics: Investing |
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