There is an old saying “Don’t put all your eggs in one Basket’ and this holds true even with respect to stock market and personal finance.Diversification is a basic rule which needs to be followed during investing.Diversification here means investing your money in different instruments and minimizing your risks. All those instruments might not be related to stock market.
For example…Investing some of your money in gold,investing some of your money to buy some property, and putting rest of it in the stock market.So even if one of the option do not work well,you will atleast have other things.
Now the question is how should you allot your money.That needs to be carefully thought over by you considering your risk profile.
Diversification in your stock portfolio helps you in protecting your money against the market fluctuation. So for example if the stocks in Pharma sector are not doing well then the stocks in some other sector in your portfolio might be performing well. Infact diversification is a must rule to follow in Portfolio management.
Diversification protects you from risks associated with your investments and makes sure you do not loose all your money.
We will try to look at with an example – You have invested all your money in buying Gold (No diversification) and you expect the prices to go up in near future.However the expected did not happen and due to some unprecedented events the price of gold hits the rock bottom resulting in a big loss for you.
Consider the same scenario again – If you had invested only a chunk of your investment in Gold (10% – 15%) and invested the rest of amount in some other instruments you would not have suffered such heavy losses.
If you think about it logically diversification will be the first natural thing which will come your mind while investing your money.