April 5, 2019

Why diversify your stock portfolio?

No matter how complex the financial and stock market world may seem, it is often subject to the same fundamental principles as the rest of the everyday world. One of these principles is diversification. The idea behind it is very simple: whoever 'diversifies' will distribute. He does something several/ multiple times. In the context of capital investment, this means: Whoever diversifies, tries to spread out the risk of his or her investment, i.e. minimize it. Instead of relying on a single company in the hope that their stocks will shoot through the roof, one prefers to rely on several different stock companies. The positions in the portfolio are made 'multiple times'.

Your own investment capital is similar to a Venetian house that you build on stilts above the canals: you can decide to build it on only a few large stilts or many smaller ones. In case a stilt breaks away, it would be less tragic if it were one of twenty instead of one of only three. So the greater the investment burden on various stocks, the lower the risk of losing all your capital. Thinking in three steps: diversification = risk diversification = risk minimization.

But like everything in life, this principle also has a downside. A disadvantage of diversification is that risk minimization is accompanied by profit minimization. Entrepreneur icons such as Bill Gates, Warren Buffett, Jeff Bezos, Larry Page or Sergey Brin have become so rich because they focused primarily on their own company. They 'focused' on their business. They put everything in one basket. Higher risk can lead to a higher reward.

But you shouldn't be blinded by potential wealth. Because only very few entrepreneurs who concentrated on their company have become rich. Very, very many go bankrupt. Alone In Switzerland, this happens to more than 10,000 entrepreneurs per year.

For this reason, the challenge lies in finding the right balance. A balance between the opposing principles of diversification and concentration: Build up your portfolio in such a way that the entire investment is not endangered in the event of a stock crash; at the same time, the risk should not be spread so widely that potential profits no longer carry any weight.

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