When it comes to investing you are always looking for the investment that can provide you the best return for the lowest risk.
Portfolio Theorists designed mathematical proofs that demonstrate that you can achieve better risk/return ratios when combining more than one investment together. Generally, they saw that the more dissimilar the combined investments were, the greater the boost in their combined risk/return profile.
Combining a set of investments that are dissimilar is called Diversification.
Intuitively, diversification refers to "don't put all your eggs in one basket." If something bad happens that has a negative effect on one of your investments, holding other investments that are very dissimilar make it is less likely to also negatively affect those investments.
Is there a limit to diversification?
Imagine you were able to invest in every single investment available in the world. Would you be able to generate a profit? If one investment profited would another incur a loss?
Some professionals hold thousands of investments in their portfolios. Ray Dalio is a good example of a professional who fully endorses the principle of diversification.
Other professionals like Charlie Munger (Warren Buffet's partner) preach: "True professionals should be able to choose the best investments, being too diversified is a sign of being unskilled."
Regardless of where you land on the professional spectrum, everyone diversifies to some degree. The question is more how much.
How do I improve my diversification?
While there are many ways to slice investments in terms of similarity the elements we focus on at EquitySim are: Asset-Class Type, Country, and Industry. Our Diversification Score measures how you are spreading your portfolio across these areas.
Find your score under the "Performance Tab":
We require that you showcase an understanding of basic Portfolio Management as a starting point for recruitment opportunities.
To qualify for recruitment opportunities, you must hold at least one portfolio with a Diversification score of 80+.
We challenge you to try building a diversified portfolio!
For additional learnings, check out these articles:
How to build a basic portfolio