What is diversification? | StudyDaddy.com

Diversification means not investing money only in one or in a few investment products.

When talking about stocks, there are two types of risk that inverstors face: systematic risk and specific risk. The sistematic risk has to to with the economy as a whole, while the specific risk, generally speaking, is related to the market in which the company is in.

So, compare two different companies: AT&T and Wal Mart. If the economy as a whole goes bad, probably people will spend less money using AT&T services and, at the same time, whi try to save money and buy only the items that are more essential to them. Therefore, both stocks will go down. The opposite happens if the economy booms. This is an example os systematic risk.

Nevertheless, still comparing those two companies, it a hurricane destroys some cell towers, AT&T will have losses, but Wal Mart will be still probably ok. this is an example of specific risk.

The diversification is about buying, for example, stocks from different companies acting in different markets. This way, if something bad occurs in one market, your loss will be smaller than it would in case you have invested all your money in one company of that market. You can also have diversification when investing in government bonds, etc.

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