Investment Diversification Simply

Welcome back to Il Chiaro Finanziario!As we mentioned in previous posts, diversification in investments is a fundamental way to limit the intrinsic risks in every investment. A key strategy for financial safety is Investment Diversification. To better understand why it’s so important, imagine investing all your money in buying a single business or company. If that business fails, you would lose all your money. But if instead of putting everything there, you had invested 50% in that business and the remaining 50% in another, the probability that both would fail simultaneously is much lower, and even in the worst case, a part of your money would likely be safe.

Understanding Investment Diversification

In simple words, Investment Diversification means dividing your investments into several parts and spreading them across different things. The objective is precisely to limit losses in case a single investment (like a specific business or stock) goes badly, thereby reducing the overall risk of your portfolio. It’s like not betting everything on a single horse, but betting on multiple participants in a race.

How to Achieve Investment Diversification

Diversification can be achieved in several ways. It can be done by country, by sector, by asset type, by company size. Let’s see how:

• By Investment Type (or Asset Class): This means including various assets in your portfolio, such as stocks, bonds, real estate investments, etc. Naturally, we are not obliged to own all of them, but a division helps to mitigate the effects of macroeconomics (like interest rates or central bank decisions). This is because different assets often yield different results based on the moment the world economy is in: sometimes stocks do well and bonds less so, other times it’s the opposite.
• By Geographical Area or Country: Another type is by Geographical Area. It means owning assets that can be US, European, Chinese, etc. Having them from different countries helps precisely in cases where a specific nation (or geographical area) has unexpected economic problems or events that heavily influence only that region.
• By Sector: Diversifying by sector means investing in companies from different industries. They can be pharmaceutical, technological, energy, and others. As you well said, certain sectors called defensive perform better in times of economic difficulty (because they deal with essential products like food or medicine), while others, like technology, yield significant gains in times of prosperity but tend to lose value in crises. Having both helps to balance.
• By Company Size: You can also diversify by company size. Large-cap companies (i.e., those that are “worth more” on the market) tend to have more contained and constant price movements, being more solid. Small and Medium-sized Enterprises (SMEs), on the other hand, can be “surprises” in the long term with very high potential gains (because they start from a lower base), but also entail greater risks and volatility, potentially leading to significant losses if they are not successful. Having both in your portfolio balances stability and growth potential.

Mutual Funds and ETFs: Diversification Within Reach

For a person who doesn’t have the time or doesn’t want to actively dedicate themselves to choosing and monitoring every single asset, a very simple way to achieve broad diversification is through Mutual Funds or ETFs. With these instruments, you choose the amount to invest, and diversification (by type, geographical area, sector, size, etc.) is already built-in: it’s done by their expert managers (for Funds) or is achieved by replicating already diversified indexes (for ETFs). It’s a practical way to invest in an already diversified “basket” without having to buy hundreds of individual securities. We have already discussed in detail what Mutual Funds and ETFs are and how they work 

Warning: Diversification Of Investment Doesn’t Eliminate All Risks!

Diversification is an excellent starting point, together with money management (which we will address in a future post), for limiting risk in investments. However, it is fundamental to understand that this does not eliminate all risks. World financial crises or very serious economic events can still cause the value of your investments to decrease and make you lose money, especially in the short term. Diversification reduces specific risk (that related to the individual choice), but not general market risk.

Conclusion

So, we have explored the importance of diversification and how you can apply it to make your investments more resilient. Remember, spreading risk is a wise move to invest with greater peace of mind. Thank you for reading this article! I hope it helps you better understand how to protect your investments. Keep following Il Chiaro Finanziario for other simple tips on the world of personal finance!