Diversification

Diversification refers to the strategy of reducing the overall risk of a portfolio by spreading capital widely. This principle is based on the simple realization that cluster risks should be avoided. Instead of tying the fate of one's assets to the success of a single company or a specific industry, investments are spread across a variety of different securities.

Effective diversification involves several levels: it encompasses various asset classes such as stocks, bonds, real estate, and commodities. In addition, geographical diversification across continents and currency areas is advisable. The key mechanism behind this is correlation. Since different markets rarely move in lockstep, gains in one area can cushion losses in another. The goal is not maximum return, but more stable growth and protection against existential setbacks. Diversification smooths out price fluctuations and ensures that a single failure does not jeopardize the entire foundation. In modern portfolio theory, diversification is the only way to optimize risk without sacrificing return opportunities. Company- or industry-specific risks, i.e., unsystematic risks, can be minimized or even completely eliminated. We will discuss this topic in more detail in the following blog post:

https://www.truewealth.ch/blog/put-all-your-eggs-in-one-basket-diversification