One of the most important aspects of investing is diversification. This is what keeps a portfolio in good health and protects the investor when the market is weak. While this strategy limits a portfolio’s growth, it prevents a loss of funds when they are most needed.
Diversification is also good for the public, according to research by the Journal of Finance. Investors benefit through efficient distribution, along with the markets and the economy as a whole. Despite this, people are more inclined to invest in non-diverse ways, which drives a trend among their peers.
The Economic Connection to Individual Risk Taking:
Those who take on questionable investments put the economy at risk. This creates a roller-coaster effect of extreme highs and lows. When things are good, people have job security and home equity, which makes it more likely for them to take financial chances in the stock market. As the upward cycle reaches its limit, the risk level increases until stocks become overvalued and inflation begins.
People are essentially herd animals, and this tendency has a large effect on investing. It occurs because of a fear of missing out on something good or simply wanting to keep up with trends. This is what attracted so many to the Ponzi scheme set up by Bernie Madoff and what drives the buzz around cryptocurrencies. Investors tend to be enthused or afraid in large groups. An example of this behavior occurred during the Thanksgiving holiday in 2017. Coinbase, a large bitcoin exchange located in the United States, took on 100,000 new accounts in a matter of days. This trend was likely driven by family members sitting around their dinner tables and discussing finances.
Why Diversification Leads to Stability:
While people can contribute to risk, they can also avert it by using diversification. By focusing on the big picture and resisting current trends, investors can help keep the economy mostly stable and less prone to volatility from the markets. One individual may think they do not make a difference, but in reality, that person’s actions are like ripples in a pond. This is especially true if the person convinces those in their social circle to engage in responsible investing. This group will inform its friends and family about this strategy, and those people will pass it on as well.
Like many things in life, proper investing is a combination of knowledge, timing and balance.
Davenport Laroche is a Hard Asset Alternative Investment Company located in many countries including the United Kingdom.