Originally published on: MoneyGeek
A wise person once said: “Do not put all your eggs into one basket”.
An investor will do well to heed this advice. Diversification means spreading out your investments, so that you’re not vulnerable to any bad news. You’re properly diversified when your investments are unrelated. The fate of a nickel mine in Australia is unrelated to the fate of a software company in Toronto. Suppose you invest in both; to wipe out your investment, both the nickel mine and the software company would have to fail. It may be unlikely to see one of them fail, but to see both fail would be truly rare. You are safer by holding both of these companies, than by holding just one.
However, you’re not properly diversified if your investments are correlated. An example might be a car manufacturer, and the company that supplies its engines. Bankruptcy for the car manufacturer can lead to the bankruptcy of the supplier. If you invest in both these companies, you are still just as vulnerable as investing in only the manufacturer.
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