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Precious metals investment terms A to Z

Diversification

Diversification is an investment strategy that calls for spreading risk and allocating resources so as to keep them from being vulnerable to external conditions, and to be as independent from each other as possible. In short, diversification is about “not putting all your eggs in one basket.”

Diversification is one of the most important principles of investing. Most of the time it refers to purchasing many stocks instead of just one or two, in order to lower risk without decreasing profits. The goal is to smooth the rate of return over time. Although one company may have problems or even go belly up, chances are slim that this will happen to 10 or 100 different companies. The same can be said about different sectors or even different types of securities. Many investors prefer to diversify between stocks and bonds and then to diversify the stock share of their portfolio among different equities.

For gold and silver investors, diversification is of the utmost importance since commodities/metals (especially sliver) are known to be very volatile. Proper diversification can mitigate the effects of this volatility. Junior mining stocks are an important part of the precious metals market, and in this area especially diversification is a must.

Based on our experience, diversification is one of the most important principles that novice investors tend to overlook. If you fall into this category, please take your time to be sure you understand this concept.

Diversification can be viewed from the perspective of both companies and individual investors.

For both companies and investors, diversification is a method of risk management. From the investor's point of view, allocating resources and diversifying investments can help lower risk. Diversification can be utilized across different asset classes (stocks and bonds), among sectors, individual companies, strategies (long-term investments and short-term speculation) and geographical areas.

Companies are able to lower their risk exposure by diversifying their operations in many fields (for example, different regions, markets and target customers).

For companies, diversification is generally about avoiding centralization of any kind. By diversifying its operations, a company is less vulnerable to a negative event in any one area.

Here is an example to clarify this concept. Suppose you are participating in a 100-mile dogsled race and the objective is to reach the finish line in the shortest time possible. You can choose either a dogsled team of two extremely strong Huskies with loads of stamina, or a herd of 10 decent dogs. Having chosen the first set you can be sure of winning providing nothing unexpected happens. For example, if one of the dogs refuses to cooperate or breaks a leg, you lose 50% of the potential and will likely lose the race. But having chosen the second team, if one of the dogs is out of commission you are much more likely to recover because you lose only 10% of your team and the other nine can pick up the slack. This is the basic concept of diversification - always allocate resources in such a way as to keep them form being vulnerable to external conditions and to be as independent from each other as possible.

Diversification is often key to success and every investor should keep this in mind when constructing a portfolio.

Portfolio diversification was developed and systematized in the 1950s by Harry Markovitz who came up with Modern Portfolio Theory, which gives a formula for minimizing the risk exposure for a given return, or the other way round, maximizing portfolio return for a given level of acceptable risk.

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