Question

Explain how can the diversification reduce risk?

Answer 1

"Don’t put all your eggs in one basket" is a very famous quote by Don Quixote.

What did he mean by that ?

He referred to the risk an event may bring that impact all your eggs at the same time and you would have no eggs left. (Eggs implies investment, business or money )

Diversification is a process in which you diversify i.e. invest your valuable resources in different shares ,businesses or holdings to alleviate your returns ,but at the same time to handle the risk.

For instance, if you have investment in 2 companies, 1st one is a Chinese company and another is American. If due to some political changes or a government policy ,Chinese company loses its market and the stock price falls, you'd lose your investment ,but at the same time you gave American holdings that will keep you afloat ,or may be even gain advantage due to the exit of chinese company. That's how diversification works ,where you have different investments ,not all are equally impacted by risks ,which gives you a safety net.