June 18th, 2009 | 
Author: When people talk about making a diversified investment in a stock portfolio, they are referring to the attempt to reduce the risk by investing in a lot of companies at once.
Most professionals agree that making a diversified investment is no guarantee against loss.
Still, it is a good strategy to adopt long-range financial objectives through this method. There are many studies that show why diversification works and most of them explain that spreading your investments across various sectors or industries will reduce price volatility.
This is especially important because it provides a more consistent overall performance on your investments and makes a more steady increase in your profits.
For any beginning investor, It is always important to know that no matter how diversified you are in your investments, your risk can never be shrunk down to zero. You can reduce your investment risks with individual stocks but there are always going to be inherent risks that affect nearly every stock.
No amount of diversification is ever going to prevent that risk. Still, good investments usually carry with them a certain amount of diversification so as to cut down on the level of risk and thereby present any big disasters.
Many beginners often ask the question of how many stocks they should own to be adequately diversified. It is usually a good policy to own five stocks rather than just one but it is still not altogether clear at what point adding more stock will cease to eliminate your risk.
Risk is defined by volatility levels. That is, the more sharply a stock moves within a period of time, the riskier it is. A statistical concept known as standard deviation is something that is used to measure the volatility of a stock.
In other words, standard deviation means “risk”. If you are properly diversified, however, you can reduce the risk associated with standard deviations and still maintain a hold of your stocks over the long term.
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