Introduction (What Is Portfolio Diversification?)
Portfolio diversification refers to the risk management strategy in which investors spread money across various financial assets instead of putting money into single asset. The main objective of portfolio diversification is to reduce portfolio risk. In this post we are going to explain some major benefits and drawbacks of portfolio diversification that helps investors to maximize returns.
Pros Of Portfolio Diversification
The main advantages or benefits of portfolio diversification can be pointed out as follows:
1. Risk Reduction
Spreading money across different assets such as bonds, stocks, real states, commodities etc. helps to reduce the impact of single investment performing poorly. So, portfolio diversification helps to reduce portfolio risk.
2. Lower Volatility
Another benefit of thus strategy is that diversified portfolio tends to experience lower volatility. It helps to reduce the impact of market fluctuations helps the investors to protect capital.
3. Stable And Predictable Returns
Portfolio diversification can produce more consistent and stable returns because it experiences fewer ups and downs. Therefore, it is suitable for long-term investors.
4. Exposure To Wider Market
Portfolio diversification strategy provides opportunity to access wider range of markets so the investors can be benefitted from high performing sectors such as real estate, commodities etc. Therefore, it provides multiple growth opportunities.
Cons Of Portfolio Diversification
The main drawbacks or disadvantages of portfolio diversification can be listed out as follows:
1. Risk Of Over-Diversification
One of the major drawbacks of this strategy is dilution of potential returns because of holding too many financial assets. So, investors may not earn expected profits.
2. Complex To Manage
Holding large number of stocks may become complicated to monitor and manage. Managing diversified portfolio requires adequate time and effort and knowledge.
3. Higher Costs
More trading means higher transaction fees, brokerage fees, commissions etc. So, portfolio diversification is costly.
4. Lower Potential Returns
Although portfolio diversification minimizes risk it also limits upside potential of high performing stocks.
