Definition, benefits, risks, and examples of the different types of investment diversification
If you’re new to investing, there are many terms and concepts you might be unfamiliar with. Taking a moment to study a glossary of investment terminology can help get you on the same page when researching how to invest and what to invest in.
One of most important concepts to understand in relation to precious metals is the concept of portfolio diversification, a principle applied by everyone from small consumer-level investors to giant hedge funds.
Here’s what beginning investors need to know about portfolio diversification, why it’s important, and how it can be achieved.
What is a Portfolio?
Before we dive into what diversification is, it’s first necessary to explain what we mean by an investment portfolio. In finance, a portfolio is the sum total of all of a person’s investments. In other words, every time you buy shares of stock or some type of physical asset like gold or silver, you are adding what’s known as “capital” to your investment portfolio.
So, What is Portfolio Diversification?
Simply put, portfolio diversification is the technique of spreading the investment capital you put into your portfolio across many different types of assets. Diversification can occur both within and among categories of assets.
One example of diversification within an asset category would be buying several different types of precious metals—gold, silver, platinum, palladium, and copper. In this case, the asset class is the same, but diversification is achieved by spreading the capital out among several different individual metals.
Diversification among asset categories, by contrast, involves holding assets that are completely different from one another. For instance, an investor may set up his or her portfolio to contain both stocks and physical metals, which are subject to different economic forces and therefore aren’t likely to respond in the same way to macroeconomic trends.
Why is Diversification Important?
Diversifying an investment portfolio is one of the best ways to reduce your overall investment risk. Consider, for example, a portfolio that contains only one asset. If that asset were to suddenly lose a large amount of its value, the investor holding this hypothetical portfolio would suffer considerable losses from which he or she may not be able to recover.
Now, suppose this asset made up only 10 percent of the investor’s overall portfolio, which contained nine other assets of various type. If that one asset should lose a significant amount of its value, the investor may still suffer losses. However, only the capital that is invested in that one particular asset will be exposed, limiting the maximum potential loss to 10 percent.
If your portfolio is made up entirely of stocks, a general stock market crash could wipe out a considerable amount of its value, regardless of how many stocks it contains. If your portfolio had been diversified with bonds, real estate, precious metals, and other assets, however, the risk would be limited by a lower overall exposure to the stock market.
As you can see, portfolio diversification is critical for investors. Though an individual asset, especially a stock, can gain or lose value on its own at any time, there are larger economic forces that can cause entire classes of assets to lose or gain value. A portfolio that is well diversified among different classes of assets can therefore ride out regular ups and downs, as well as large economic upheavals that take place only once in a while.
What are Different Ways to Diversify?
Since there are many different types of investment assets, the number of ways you can diversify your portfolio is practically limitless. For any investor, a good place to start is by acquiring low-risk precious metals like gold and silver. Precious metal coins and bars are less affected by market downturns and, in fact, tend to have an inverse relationship with the economy.
Precious metals—such as gold, silver, platinum, and palladium—are among the most historically stable assets. These metals usually retain their value under even the worst market conditions, a fact which has led most major world governments to keep large quantities of physical metals in reserve as a hedge against severe economic downturns.
Getting started in precious metal investing is remarkably simple, since it only requires buying a physical metal. For investors working on smaller budgets, silver is often a good place to start. If you have the capital necessary to buy gold, though, it is often wise to acquire at least some of it. You can diversify the precious metals section of your portfolio by buying more than one type of metal at a time.
Gold and silver are often bought in the form of coins, but bars and non-coin rounds are also commonly available. Platinum and palladium are rarely used in coins, though certain mints around the world do issue special bullion coins made out of the metals.
Once you’ve purchased one of these stores of a precious metal, you can simply hold it as a safe reserve of value until the time comes that you feel you should liquidate it. If you really want to be able to ride out even the worst economic downturns, a diversification strategy based on physical assets is usually the best way to go.
Whether you’re looking to diversify your investment portfolio or simply enjoy collecting beautiful coins (or both), Provident Metals has what you are looking for. Browse our selections of gold bullion and silver bullion today to get started.