Why does it make sense to diversify your investment?

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Financial lexicon Financial lexicon

Diversifying an investment means dividing the total amount across several financial assets. So investing in multiple activities can lower your risk.

A financial investment has the following risk components:

  • Systematic risk: also known as market risk, it is the risk component of an activity that is linked to its reference market.
  • Non-systematic risk: this risk, also known as specific risk, results from specific elements of the company and its industry.

The Harry Markowitz Theory

The secret to creating a “low risk” portfolio, or rather, mitigating the risk of a portfolio, is therefore to diversify the components of the portfolio by increasing the number of financial assets it contains. These activities are not intended to have any interrelated performance.

The essence of this principle, described by the Nobel Laureate in Economics, Markowitz, is that non-correlating assets succeed in eliminating the risk defined as specific, i.e. the risk of the individual instrument. However, there is still a systemic risk that can’t be completely eliminated.

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