Diversification is crucial for managing risk in investments from "summary" of How Finance Works by Mihir Desai
Diversification is not just a nice-to-have in the world of investing; it is absolutely essential for managing risk. By spreading your investments across a variety of assets, you can reduce the impact of any one investment performing poorly. This is a fundamental principle that every investor should understand and apply in their portfolio construction. When you put all your eggs in one basket, you are essentially putting yourself at the mercy of that one investment. If it goes south, you could stand to lose a significant portion of your wealth. However, by diversifying, you can minimize the impact of any single investment underperforming. This is because different assets tend to behave differently under various market conditions. For example, when stocks are doing well, bonds might not perform as strongly. Conversely, when stocks are struggling, bonds may provide a more stable return. By holding a mix of stocks, bond...
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