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Diversification is good to manage risk in your investment portfolio and here we will look into what diversification means for investments and its pros and cons.

Diversifying your portfolio is spreading money where you invest in, including cash, shares, fixed income investments, property, bonds or other alternative assets such as private equity, cryptocurrencies, hedge funds or gold. Each asset class has its own risks, pros and cons so your investment portfolio must reflect what you want to achieve with it.

You can diversify within each asset class as well. You can spread your share investments across mining companies, healthcare, tech, etc. You can invest in Australian and international markets so if one economy faces a downturn, your portfolio won’t be impacted much.

Diversifying creates a safety net for your investments so your portfolio doesn’t fail completely if one asset class does. It protects from market volatility. Other asset class may grow, some neutralise or even lose.

When you invest you face market or systematic risk, wherein risk involved is with a particular market. It is market volatility which is inherent to investing. It reflects economic, financial and political situations. This risk is most common in currency, commodity, interest rate and equity investments. It can be seen in interest rate changes, natural disasters or recessions.

Another risk is liquidity. You can’t sell your investment right back into cash in an instant so you might have to lower the price. Longevity risk is outliving your investment and savings while concentration risk is when you do not diversity your portfolio.

Diversifying your portfolio may feel complicated and if you overdo it, it can lead to lower quality investments with below average returns as you’ve mixed low quality investments with good ones. However, you can negate these by planning. It’s good to hedge against risk and not focus on one asset class. Diversifying is a good investment strategy that allows you to benefit from different market segments and reach your financial goals.

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