Having a diversified portfolio is essential for any serious investor. There is a good reason behind the popularity of the phrase, “don’t put all your eggs in one basket” when it comes to assets. One basket, in this case, would be equivalent to investing in only one asset – and if the value of that one asset falls to zero, the whole investment can be lost. Choosing to invest in multiple assets is known as “diversification”. This can be done by either investing in multiple asset classes or by investing in multiple different assets within one asset class. Asset classes differ from one another in the nature of the source of their value. For instance, commodity funds invest in raw materials or primary agricultural products, whereas Forex is a money market asset in which foreign currencies are traded. In the event of one of the assets failing, a diversified portfolio can help to prevent big losses. You would have the ability to significantly offset the loss of the falling asset if you had other investments. However, in order for this to work effectively, the correlation between the assets in a potential portfolio must be taken into account. An everyday life example of correlation would be that during winter, the sale of coats would go up. Therefore, cold weather and coat sales are positively correlated. The occurrence of one and the sales of the other respectively tend to move up and down together. This is why when investing i...
