Diversification, as defined by Investopedia, is a technique that reduces risk by allocating investments across various financial instruments, industries, and other categories. It aims to maximize returns by investing in different areas that would each react differently to the same event.
Therefore, if you diversify, unpleasant price swings will be offsetted by positive results in another industry or asset. Location can be another form of diversification. Though United States listed stocks are most reliable, there can come a time when they are underperforming in relation to equities from another part of the globe. Ray Dalio’s ‘Holy Grail in Investing’ nicely summarizes the importance of the strategies listed above.
Though the chart can look confusing at first, its message is quite clear after looking at the summarizing data table on the right. It basically states that as an investor increases the number of uncorrelated assets in their portfolio, their probability of losing money in a given year decreases. An uncorrelated asset can include commodities and bonds or stocks in various industries. After around ten uncorrelated assets, your loss probability becomes vastly minimized in relation to only owning one. Because of the dramatic decrease in risk, long-term holding using the principle of diversification is the most effective and globally accepted method of profitably investing.
For additional information, purchase the book titled Beyond Diversification by Sebastien Page linked below.