Quora Answer: Is Diversification Really the Key to a Good Investment?

The following is my answer to a Quora question: “Is diversification really the key to a good investment?”

The primary purpose of diversification is to mitigate exposure to any one section of the economy and spread the risk.  It is about risk management, and not growth.  It is not the key to good investment.  It is a hedge against loss.  The key to a good investment is relative to your investment horizon.  A good investment needs to have sound fundamentals on the underlying asset.  This is especially important for leverage products, and wrappers.

It is true, however, that sound diversification allows you to take advantage of growth in other areas when you are experiencing a loss of value in commensurate asset classes.  For example, bonds and debt instruments tend to rise when stocks and equity fall, and vice versa.

Diversification also affords you some flexibility since some asset classes are more liquid than others, and have a ready secondary market.  This allows you some flexibility when managing your portfolio.  You may also diversify across risk categories, which allows you to take advantage of growth, yet mitigate losses in a general downturn.