Question

-What is the benefit of diversification and how do mutual funds do this more effective than an ordinary investor?

Answer 1

The benefits of diversification is that the unsystematic risk of the stocks are eliminated and the stocks are only exposed to market risk, this brings down the overall level of risk in the market.

Diversification helps minimize the losses, as the loss in one stock s minimized by the positive news on the other stocks. Thus, the potential loss of the overall portfolio is mimimised. Rather on concentrating the entire capital in one investment, diversification helps gain exposure to different sectors of the market, thus minimizing the overall loss.

The mutual funds are large investors and they have the necessary expertise and time as well as the necessary resources to allocate capital among the different sectors of the market. The small/ordinary investor lacks the time, money and skill to diversify his portfolio and enjoy the benefits of diversification. Since the mutual funds hold 50 to 100 different investments all at the same time, they can enjoy the benefits of diversification. For a ordinary investors making such large amount of investments is difficult and time-consuming.