Diversification

Diversification means spreading risk; it is the well-established way of lowering systematic risk, and every investor is well advised to diversify’. For the purposes of risk reduction, it is necessary to distinguish between systematic risk, which can be reduced by diversification. and market risk, which cannot he eliminated. The benefits of diversification are greatest when the markets traded are very different and the methods of making decisions are also unrelated. Typical investment portfolios contain a variety of fixed income. equities. real estate, art, as well as different investment philosophies, all intended to provide different rates of return with different patterns and not suffer losses all at the same time. Unfortunately, this is not always the case. Market risk, including catastrophic risk, is not predictable, and can surprise even the best investors. Avoiding market risk is the subject of this and other sections in this series of posts.