How diversification helps?
There is a little story on the SEC website that explains the advantages of diversified investments beautifully. Have you ever noticed that street vendors often sell seemingly unrelated products – such as umbrellas and sunglasses? Initially, that may seem odd. After all, when would a person buy both items at the same time? Probably never – and that’s the point. Street vendors know that when it’s raining, it’s easier to sell umbrellas but harder to sell sunglasses. And when it’s sunny, the reverse is true. By selling both items- in other words, by diversifying the product line – the vendor can reduce the risk of losing money on any given day.
Diversification involves spreading your money among various investments in the hope that if one investment loses money, the other investments will more than make up for those losses. A diversified portfolio should be diversified at two levels: between asset categories and within asset categories.
One of way of diversifying your investments within an asset category is to identify and invest in a wide range of options that may perform differently under different market conditions. This has to be done while making sure that at all times, a relatively large part of the portfolio is held in safe instruments such as cash, index funds and a basket of bonds.
This is exactly where PROFITMONK algorithms score. Look at the graphic below. It shows how much of the invested portfolio was held in cash at the end of each year. It's clear that by holding a large portfolio in cash, the asset allocation optimizes the risk vs. return equation beautifully.
Super efficient use of cash
In conclusion, investors can flourish if they apply a smart approach to investing through diversified basket of options, while keeping their nest egg safe.