Why is it important to diversify investments?

There is a basic principle in every investment: diversify investments. Unless you go for it and are willing to take a huge risk, you should not put all the eggs in the same basket. Diversification is the way we have to reduce risk by distributing our money in different assets.

Imagine that you do not do it and invest all your savings in one company. Maybe that company is currently going through a golden period and its profitability is maximum. But what would happen if it suddenly went wrong? The answer is very simple: you will lose money. And if one day that company collapses, your savings will be in danger.

Diversifying investments does not guarantee that you will not lose money. Investing is risky and unpredictable. Nothing and nobody can assure you that a turn of the markets does not put your profitability in negative. However, good diversification reduces the chances of an investment going bad.

So we reduce risks by diversifying

Nothing better than an example to explain it. Imagine that you do not diversify your investment and that you decide to bet everything on a single company, 10,000 euros, for example. If for any reason the shares of this company fall 15% in a single day, you will have lost 1,500 euros.

On the contrary, if you had diversified into only two companies (5,000 euros in each), the collapse of the first would have resulted in a loss of “only” 750 euros. But if the other company is positive and up 5% that day, the loss would be “only” 500 euros.

Now imagine that you had distributed your investment in ten different companies: for example, 10% of your money in each of them. The fall of 15% of the initial company would have meant for you a loss of only 150 euros, which surely would have been compensated with the benefits of the other nine companies. As a result, almost certainly you would not have lost money that day.

What is the best way to diversify investments?

There is no scientific method that can be applied to everyone to achieve a good diversification of a portfolio. The decision to diversify in some companies or in another will depend on the risk you want to assume and the profitability you want to obtain.

The more diversified a portfolio is, the less risky it will be. However, it may happen that at a certain point, more companies in the portfolio do not generate a greater benefit. Therefore, the risk/return ratio is the only one that can help us make a decision.

In general, a well-diversified portfolio is one that integrates companies from different sectors and different countries. If the objective is to reduce risks, we will achieve this by investing, for example, in Spanish, American and Asian companies. If also some are dedicated to the primary sector, others to the tertiary and others are technological, less likely that things go wrong.