What is diversification

Stocks - basic knowledge

What is diversification?

Diversification means the spread of assets over several investment objects and is a term that is widely used in economics. In the strategic management of companies, he describes the development of new business areas with the aim of securing growth and balancing out risks.

Already 2000 years ago it was common for the Babylonians to keep their wealth in equal parts in land, business and liquidity. This "naive", that is, arbitrary diversification describes the distribution of assets over several different investment objects when building a portfolio. The aim is to reduce the unsystematic risk of the portfolio. In this context, unsystematic risk means the risk that an investor takes if he invests all of his money in just one share. The probability of achieving a high loss is therefore lower with a portfolio with many different securities than with a portfolio that consists of a few stocks. As the number of securities increases, the risk of the portfolio falls and adjusts to the systematic risk of the market. Further diversification of the portfolio then no longer leads to a risk reduction.

Since Harry M. Markowitz's "Portfolio Selection Theory" (How do I optimize my portfolio?) Published in 1952, diversification has gone beyond naive spreading across different investment objects. In addition, the correlation, i.e. the linear relationship between two securities, is considered here. It is then possible to use securities that are not perfectly positively correlated with one another to create efficient portfolios, that is, to create a portfolio that is optimal in terms of both risk and return.