> Introduction to Diversification

Introduction to Diversification

Posted on Friday, December 7, 2012 | 1 Comment

Diversification is important when investing, and it's a topic I want to briefly explain in this post, and eventually go more in depth later. To be brief, I'm going to cover a few general principles and reasons for diversification.

1) Don't put all your eggs in one basket.

Simply put, if you drop a basket that has all of your eggs in them, every egg will break, and you'll have no eggs left. In investing terms, as an extreme example, imagine you invest all your money into one company. If that company manages to go bankrupt, you literally lose all that money. The beauty of diversification is that you can minimize risk and potentially minimize losses too, if you do it correctly. It's a very advanced topic and will thus only be covered briefly for the fundamentals.

To minimize risk in the basket of eggs case, imagine having 10 baskets each with 1 egg. If you drop one basket and the egg breaks, you only lose 1 egg instead of all 10 if they were in the same basket.

2) Don't just invest in stocks

In order to maximize diversification, this cannot be done only with stocks. As Benjamin Graham's book "The Intelligent Investor" states, a portfolio should typically have 25% bonds and 75% stocks. This is a very general statement as things can get further complicated as an investor becomes more adept. This leads us to the next rule.

3) Don't just invest in bonds and stocks, GIC's and TFSA are important too

To further diversify and minimize risk and losses, one can structurally plan to buy stocks in different countries, invest in real estate, private equity, infrastructure, and commodities. If you live in Canada, it is of utmost importance to invest in GIC and Tax-Free Savings Accounts. These are virtually zero risk and although the return is low, it is better than having money vacant.


Although this post wasn't in depth and possessed a little redundancy, I hope it got the point across. Diversification is a complex topic and there are people who work in risk management -- in fact there are risk management departments at many banks. A solid investor allocates his investments so that if, for example, stocks manage to give subpar returns in Canada, this can be partially offset by higher returns in bonds, foreign stocks, etc.


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