What is risk diversification and why should it be distributed?

What is risk diversification and why should it be distributed?

What is risk diversification and why should it be distributed?

There are 5 types of risk distribution. There are various classifications, however, for beginners, this classification will be most useful.

Tool.
Institutional
Species.
Transit.
Monetary.

Let's look at each type in more detail.
Instrumental diversification

In this case, investment risks are distributed across different financial instruments within the same business area or asset. Any activity based on money is always dynamic. You can't be 100% sure how events will develop further.

Let's go back to Alexey. For example, if it has an investment portfolio, then in addition to risky financial instruments (stocks, raw materials), it also contains bonds. That is, the shares can give a potential large profit, but there is a risk of losing your investment. Bonds also provide some balance, they are safe, however, can not give large profits compared to stocks.

Another example:

Simultaneous investment in a cafe and a car wash.
Simultaneous investment in PAMM accounts and Bank deposits.

Institutional diversification

You can also distribute your financial risks within a single asset or instrument. For example, there is such a form of investment as backing. This is an investment in professional card players. Here is an excerpt from an interview with Jason Mercier, a professional card player and part-time successful backer:

I started investing in players in October 2008. Then I sponsored Brent Hanks and Dan O'brien. I tried it because I had learned a lot about the game and how these guys play. At the time, it seemed like an easy way to make a profit. They played well and I thought I would make a huge amount of money from their game as well. But then I realized how important it is to bet on more than one or two professionals. Of course, this requires a lot of effort, but it pays off handsomely.

Another example:

Simultaneous investment in shares of Google, Microsoft, and Nintendo.
Simultaneous investment in gold and silver.

Species diversification

This is a global distribution of their financial risks. This, of course, will require more time and effort to understand all the areas in which investment will flow. For example, Alexey will invest simultaneously in a retail store, securities, and deposits.
Transit diversification

This is an investment in areas where there are different options for withdrawing your funds. The fact is that an investment project, even with a stable profit, may be at risk due to one type of withdrawal of its finances. Such situations when the investor cannot withdraw their earned money occur with periodic frequency.

Take for example the situation in November 2016, when Skrill payment system cards suddenly stopped being issued in Russia, or, for example, the situation with Webmoney in Ukraine, when a huge number of accounts were seized and it was impossible to withdraw their funds.
Currency diversification

Investing in different currencies helps the investor protect against various fluctuations in exchange rates. The main examples here are:

Investments in Bank deposits in national currency and dollars
Investing in trading on world exchanges in euros and dollars

Conclusion

What are the goals of risk allocation? The main goal of diversification is to reduce the overall risk. As a result, with proper diversification, the profit, at least, remains at the same level. Even if one of the instruments turns out to be unprofitable, this will not affect the other investments in any way.

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