Hi everyone, here is the fifth post from my series 'Education for new investors'. I will be sharing my knowledge on topics surrounding investing and readers do not require prior financial background to understand the posts.
❓ What is meant by "Diversification" ❓
Diversification is a concept very easy to understand. Diversification means to invest in different stocks of different industries, or even sometimes unrelated to the stock market such as bonds, real estate, etc...
Very related to the old idiom "never put your eggs in one basket"
🤷♂️ But why should I diversify my portfolio ? 🤷♂️
There is always an element of risk when you invest and diversification is a way to reduce this risk.
In March 2020, due to the COVID crisis, the two biggest plane manufacturers $Boeing and $Airbus were greatly impacted by the sudden halt of commercial flight. If I would have invested only in these 2 companies, I would have lost 60% of my capital invested in these 2 companies.
Fortunately, having diversified into different industries such as Amazon and Netflix who have been doing really well in 2020, the impact was reduced when the COVID crisis appeared. This personal example is the proof that diversification has really helped me to reduce my risk and to overcome the COVID crisis.
🤷♂️ So how many companies should I invest in to be safe ? 🤷♂️
First of all, there is no guarantee that you will be 100% safe from a black swan event such as the COVID crisis or the dot com bubble.
However in the stock market, it has been proven that to invest in 15 companies within different industries, reduces your unique risk by 90%, and that you will be mainly subject to the market risk also called "systematic risk".
To measure the risk of your portfolio, you could use something called the "variance", but if you are not familiar with it, I would strongly recommend to use the risk score on the eToro platform.
This was a simple explanation of diversification.
If you are looking into getting more details, I could suggest you to search "Modern Portfolio Theory" as this offers a more detailed explanation of the concept.
If you liked this post, please stay tuned for more posts within the series. 👍🏻👍🏻