Question

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Why is it important for people who own stocks and bonds to diversify their holdings? Discuss?

Answer 1

ANSWER:

Whether be it bonds or stocks, everything has a certain amount of risk associated with them and as we know the amount of returns are directly propotional to the amount of risk taken and now we need to understand why we need to diversify our holdings.

Lets take an example of two investors A and B. investor A has invested in only 2 stocks and 2 bonds with a combined return of say 25% and investor B who has diversified his wealth in 20 stocks and 20 bonds and also has a combined return of 25% . so, now lets assume that for a year market goes down and with it the stocks and bonds and therefore the returns on each might vary and investor B who has diversified his portfolio has a less chance of losing wealth as there are 20 stocks and 20 bonds with him but investor A who has only 2 stocks and 2 bonds will be more affected as the his returns will go down and therefore it is right to say that it is better to invest in mutual funds where there is lot of diversification.