Diversification in a porfolio Research Paper Example | Topics and Well Written Essays - 2500 words

Diversification in a porfolio - Research Paper Example Graham (2010) observes that the risks of an investment are reduced to between 80-90% through diversification of portfolios. However, there have been questions as to whether portfolio diversification is the best way to increase returns of an investment and to yield higher returns. Some studies have shown that portfolio diversification only reduces non market risks when the diversification is done up to a certain degree. According to Hagin (2004), even though portfolio diversification reduces non market risks and increases the returns of an investment, the rule of diminishing returns usually applies at a very early stage of the investment. This paper therefore tries to answer the question as to whether diversification of portfolios with aggressive and defensive risks profiles the best way to invest. In order to answer the main question of the paper, the paper reviews the various aspects or factors that are involved in an investment and determines how they correlate with diversification and returns. Portfolio can be broadly defined as a collection of various financial assets that are owned and managed by an individual investor or a group. According to Hagin (2004), portfolio refers to combination of different investments assets that are mixed with the aim or purpose of achieving the goals of an investor or a group of investors in any given market and region. Some of the financial assets include equities, liquid assets, fixed income instruments, bonds as well as cash. The kind of portfolio an investor chooses strongly determines the risks and returns associated with that particular investment. Diversification of portfolios on the other hand refers to an investment strategy that involves mixing of various assets in order to reduce the risks of an investment portfolio. This is through the spreading out of the risks that are associated with each investment assets to ensure that when a financial crisis occurs or affects one asset, the other