by It is believed that holding two securities is less risky than having only one investment in a person’s portfolio. When two stocks are taken on a portfolio and if they have negative correlation, then risk can be completely reduced because the gain on one can offset the loss on the other.
The effect of two securities can also be studied when one security is more risky when compared to the other security. The following example shows a return of 13%. A combination of A and E will produce superior results to an investor rather than if he was to purchase only Stock-A and one-third of stock consists of Stock-B, the average return of the portfolio is weighted average return of each security in the portfolio.
Reduction of portfolio Risk through diversification: The process of combining securities in a portfolio is known as diversification. The aim of diversification is to reduce total risk without sacrificing portfolio return.
Domestic stocks
Stocks represent the most aggressive portion of your portfolio and provide the opportunity for higher growth over the long term. However, this greater potential for growth carries a greater risk, particularly in the short term. Because stocks are generally more volatile than other types of assets, your investment in a stock could be worth less if and when you decide to sell it.
Bonds
Most bonds provide regular interest income and are generally considered to be less volatile than stocks. They can also act as a cushion against the unpredictable ups and downs of the stock market, as they often behave differently than stocks. Investors who are more focused on safety than growth often favor US Treasury or other high-quality bonds, while reducing their exposure to stocks. These investors may have to accept lower long-term returns, as many bonds especially high-quality issues generally don’t offer returns as high as stocks over the long term. However, note that some fixed income investments, like high-yield bonds and certain international bonds, can offer much higher yields, albeit with more risk.
Short-term investments
These include money market funds and short-term CDs (certificates of deposit). Money market funds are conservative investments that offer stability and easy access to your money, ideal for those looking to preserve principal. In exchange for that level of safety, money market funds usually provide lower returns than bond funds or individual bonds. While money market funds are considered safer and more conservative, however, they are not insured or guaranteed by the Federal Deposit Insurance Corporation (FDIC) the way many CDs are.* When you invest in CDs though, you may sacrifice the liquidity generally offered by money market funds.
* You could lose money by investing in a money market fund. Although the fund seeks to preserve the value of your investment at $1.00 per share, it cannot guarantee it will do so. The Fund may impose a fee upon the sale of your shares or may temporarily suspend your ability to sell shares if the Fund’s liquidity falls below required minimums because of market conditions or other factors. An investment in the fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Fidelity Investments and its affiliates, the fund’s sponsor, have no legal obligation to provide financial support to the fund, and you should not expect that the sponsor will provide financial support to the fund at any time.
International stocks
Stocks issued by non-US companies often perform differently than their US counterparts, providing exposure to opportunities not offered by US securities. If you’re searching for investments that offer both higher potential returns and higher risk, you may want to consider adding some foreign stocks to your portfolio.
Sector funds
Although these invest in stocks, sector funds, as their name suggests, focus on a particular segment of the economy. They can be valuable tools for investors seeking opportunities in different phases of the economic cycle.
Commodity-focused funds
While only the most experienced investors should invest in commodities, adding equity funds that focus on commodity-intensive industries to your portfolio such as oil and gas, mining, and natural resources can provide a good hedge against inflation.
Real estate funds
Real estate funds, including real estate investment trusts (REITs), can also play a role in diversifying your portfolio and providing some protection against the risk of inflation.
Asset allocation funds
For investors who don’t have the time or the expertise to build a diversified portfolio, asset allocation funds can serve as an effective single-fund strategy. Fidelity manages a number of different types of these funds, including funds that are managed to a specific target date, funds that are managed to maintain a specific asset allocation, funds that are managed to generate income, and funds that are managed in anticipation of specific outcomes, such as inflation.
