New investors are usually fraught with misconceptions regarding some investment strategies. One such noteworthy strategy is diversification, which serves to mitigate risks to portfolio arising from the volatile nature of markets. Diversification basically involves adding investments to a portfolio from a variety of investment avenues such as equities, debt, real estate etc. The target is to maintain an ideal balance so that a drop in value of one kind of investment is compensated by stability in the rest of the portfolio.
However, when this strategy is used with a small kitty invested in a variety of equity sectors, a considerable amount of potential profit may be lost owing to a weak leverage from smaller holdings in stocks. A situation such as this, in investment parlance, is termed as diworsification. Investopedia defines diworsification as "The process of adding to one's portfolio in such a way that the risk/return tradeoff is worsened."
This situation can be easily rememdied by trimming from portfolio some of the slow moving stocks and consolidating positions in those that create more value. Such a move will also improve the overall leverage of the investments. This situation, however, presents a very obvious question - what constitutes an ideally diversified portfolio? Well, there really is no formula for it and a lot depends on the size of the investment capital, the risk appetite and the horizon of the investor. Having decided that, one must take positions in atleast three sectors. My current favorites are engineering, commodity, banking & finance and technology. With a contrarian view, I find banking especially interesting as the current global crisis has brought down most banks to attractive levels.
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