Diversification explained simply

basketsDiversification matters. Here’s a simple explanation … basically you want many different baskets (asset allocation) with many different eggs (diversification) within each basket.

Asset allocation is where you decide your mix based on your risk tolerance (behavior reaction to markets) and capacity (ability to manage loss or to not reach the goal).

Diversification involves the mathematics of the differences between two or more investment choices to improve returns given similar or less risk.

Everyone has an allocation, even by accident, when they hold different kinds of investments. Most people don’t have an effective diversification because the mix of those investments hasn’t been done efficiently.

Asset allocation is the broad concept that should target your risk, while diversification is a bit more complicated to apply some math principles to do it right.

The below short slide show illustrates the concepts in simple terms visually.

Also see Black Swan Portfolio Construction – is it possible?

Other prior blogs on diversification.

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