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Chapter 17: 22RQ (page 426)

Why should a financial investor care about diversification?

Short Answer

Expert verified

As it helps in the reduction of danger.

Step by step solution

01

Concept introduction

Diversification implies spreading your investments rather than placing all of your money in one stock.

02

Explanation of solution

Diversification is a strategy that prevents money from being invested solely in one instrument. Allocating money to various equities, funds, and other investments reduces risk. The goal of any financial investor is to make money. If they invest all of their wealth into one fund, would that fund face any future losses? It will be more likely to lose all at once. That is why investments are distributed across a number of equities, so that if the value of one drops, the value of the others rises to compensate and reduce the loss. Though this strategy does not guarantee against loss, it does reduce the risk, and the investor does not suffer.

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Most popular questions from this chapter

What are the most common ways for start-up firms to raise financial capital?

You and your friend have opened an account on E-Trade and have each decided to select five similar companies in which to invest. You are diligent in monitoring your selections, tracking prices, current events, and actions the company has taken. Your friend chooses his companies randomly, pays no attention to the financial news, and spends his leisure time focused on everything besides his investments. Explain what might be the performance for each of your portfolios at the end of the year.

Investors sometimes fear that a high-risk investment is especially likely to have low returns. Is this fear true? Does a high risk mean the return must be low?

What are some reasons why the investment strategy of a 30-year-old might differ from the investment strategy of a 65-year-old?

If you owned a small firm that had become

somewhat established, but you needed a surge of financial capital to carry out a major expansion, would you prefer to raise the funds through borrowing or by issuing stock? Explain your choice.
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