Question

Why do investors diversify their portfolios? How many stocks do you have to own before you have a diversified portfolio? Is it true all risk can be diversified away?

Answer 1

For any investor diversification is advisable in order to reduce the risk .

This is always said that don't keep all eggs in one basket because if the basket will fall, your all eggs will be broken.This implies that investing all your money at one place will cause a huge loss if that stock gets affected.

Same is the case with the portfolio, you should always invest in a diversified portfolio since it minimises your loss when there is downfall in 1 sector like IT, healthcare, automobile , pharmaceutical , etc.

Stock risk measure for a diversified portfolio depends upon 2 things i.e. risk and return.

There are 2 types of portfolio risk i.e. systematic risk and unsystematic risk.

Unsystematic risk can be reduced or removed by diversification of portfolio.

But, systematic risk is depended on market factors like political reasons, strike in healthcare sector by doctors, economic breakdown of country etc. which cannot be removed and will definitely affect your portfolio. Since, systematic risk cannot be eliminated, all portfolio risk cannot be eliminated.