Making your portfolio diversified across a number of various investment categories, such as stocks, bonds, and cash equivalents, and within categories,such as stocks from different kinds of companies and a mix of corporate and government bonds can help decrease your risk. But there can be some disadvantages to diversification.
Indeed, portfolio diversification is universally recommended to lessen the risks of losing money, volatility and emotional stress. However, just as it can limit downside by reducing the possible risk and volatility across a group of investments, it can also limit your upside. It is actually possible for portfolio diversification to increase your risk if it leads you to buy investments that are too risky or that you don’t even understand very well.
A more-diversified portfolio can also be more time-consuming to handle than a less-diversified one, because you need to follow and trade in more investments, adding more layers of diversification just to make sure you are following to them. If maintaining your portfolio diversification requires you to micromanage and trade more frequently, transaction costs could be higher.
Below are some disadvantages of portfolio diversification that you might encounter eventually in your investment journey.
Diversification can help you from striking out, but it also keeps you from hitting a home run. For instance, if you invest your money in five various stocks, and one takes off, the other four stocks hold back your total return.
Typically, you have the option of investing through a full-service broker, a discount broker or an online broker. Each category of broker has a unique commission format, and they all actually charge commissions or transaction fees. Placing all your money into a single investment normally can end up to a lower total fee than investing the similar amount of cash to a number various investments.
You are neither to make a huge profit from a single sector nor to suffer a huge loss, if your portfolio is widely diversified. If 5 percent of your holding unexpectedly spike, you will make far lesser profit than if 100 percent of your holdings were in that place. It is very difficult to forecast or predict where and when this will occur to an asset class or market sector. The more firmly your investments are focused, the greater risk you are actually taking, and this can lead to bigger losses or to bigger gains.
You could experience some amount loss whenever some part of your portfolio declines in value, if your holdings are widely diversified. If the overall market is decreasing, it is more likely that your holdings will perform the same thing. When you diversify your investments, you safeguard yourself from extreme financial exposure, but at the cost of missing out on probable major profits.
If you invest in a number of different stocks that all end up to be problems, your portfolio will still lose money, even if it is diversified. That’s it, portfolio diversification neither guarantees a profit, nor completely secure you against a loss.
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