What is diversification
Diversification is a risk management strategy that mixes a wide variety of investments within a portfolio. A diversified portfolio contains a mix of distinct asset types and investment vehicles in an attempt at limiting exposure to any single asset or risk. The rationale behind this technique is that a portfolio constructed of different kinds of assets will, on average, yield higher long-term returns and lower the risk of any individual holding or security.
Diversification by Asset Class
Fund managers and investors often diversify their investments across asset classes and determine what percentages of the portfolio to allocate to each. Examples of asset classes are stocks, bonds, real estate, ETFs, commodities, cash, and short-term cash-equivalents.
They will then diversify among investments within the assets classes.
Foreign Diversification
Investors can reap further diversification benefits by investing in foreign securities because they tend to be less closely correlated with domestic ones. For example, forces depressing the U.S. economy may not affect Japan's economy in the same way. Therefore, holding Japanese stocks gives an investor a small cushion of protection against losses during an American economic downturn.
Smart-beta diversification strategy
Smart-beta strategies offer diversification by tracking underlying indices but do not necessarily weigh stocks according to their market cap. ETF managers further screen equity issues on fundamentals and rebalance portfolios according to objective analysis and not just company size. While smart beta portfolios are unmanaged, the primary goal becomes outperformance of the index itself.
Pros and Cons of diversification
Source: Investopedia
