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3 Advantages of Diversification as Part of your Investment Strategy

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Investment strategy matters when it comes to investing in any financial market. If you want to invest, you must deal with the ups and downs of the market. A good week in the market leaves an investor feeling like a genius; a bad week makes an investor feel downright foolish.

In order to protect yourself from a market downturn, you must diversify. Learn more about some of the advantages that stock investment diversification offers investors.

1. Risk Reduction
You can't eliminate risk completely, but you can manage your level of risk. Every investment has some amount of risk. Young investors should embrace risk because the long-term rewards can make it worthwhile. Older investors may view risk as an enemy, because too much risk can annihilate retirement plans. In fact, many senior citizens experienced great losses to their retirement portfolios during the economic downturn.

Some investors failed to diversify amongst asset classes, and were far too exposed to stock market risk. Diversifying into safer fixed income assets may have helped to reduce their risk and maximize their returns. Using capital preservation and diversification as investment strategies can also reduce investment portfolio risk.

2. Capital Preservation
Some investors strive for capital appreciation, while some investors use capital preservation as an investment strategy. Capital preservation allows you to protect the capital you have, rather than focusing on the rate of return for your investments. Diversification makes it much easier for an investor to protect their capital, allocating money to different investments.

Investing in a variety of assets reduces risk, especially when compared to investing in a limited number of stocks. You do not have to worry about a Lehman Brothers or Enron crushing your retirement portfolio, if you lessen the impact that these stocks have on your portfolio by diversifying your investments. In addition to investment risk management and capital preservation, you can also hedge your portfolio when you employ diversification as an investment strategy.

3. Ability to Hedge Your Portfolio
Diversification can enable a portfolio to grow both when markets boom and returns crumble in one sector. Investors who have had 100% equity portfolios over the past eleven years have likely seen very poor returns. If these investors had diversified their portfolios to include investing in metals, commodities, and bonds, their portfolios would have experienced greater returns. Diversification gives an investor the chance to achieve positive returns in one market when another market is generating negative returns.

Diversification offers investors a number of benefits. Diversification is appropriate for the risk averse and works well for prudent investors. Diversification helps protect your capital from the wild swings of the market, while achieving long-term growth at the same time.

Mark Riddix is an investment management pro at New Horizons Financial Management. He also contributes tips and articles about investing and finance to Money Crashers, a personal finance blog that covers topics like insurance, investing options, credit cards, and broker reviews (e.g. see the Scottrade Review and TradeKing Review). Mark writes a weekly column for Benzinga.

Posted-In: Economics Personal Finance

 

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