Diversification involves spreading one's investment around to limit the exposure of one type of asset. The purpose of diversification is the minimize the volatility of one's portfolio over time. As the saying goes, "never puts your eggs in one basket," diversification helps an investor to balance their comfort level with the unforeseen risk against a specific time horizon. Therefore, to balance the risk and reward when investing, one needs to diversify their assets (Pirgaip et al., 2020). One can include domestic stocks, bonds, short-term investments like money markets funds, international funds, or other sector funds that focus on one sector of the economy, for instance, real estate funds.
On the other hand, risk tolerance is the ability of an investor to bear the potential of losing money after investing in something. This is based on the understanding that not every person can stomach the idea of losing money after largely investing in something. For example, a person nearly retiring may have a lower risk tolerance than a young person (Hvide & Panos, 2014) . The people who are nearing retirement may find themselves investing in bonds and saving accounts since they are less at risk of losing money than investing in stock, which is a type of investment associated with a higher risk of loss.
Delegate your assignment to our experts and they will do the rest.
Having a $100 000 investment, I would balance my investment, in that 50 % to go to stock with US stock taking 35 percentage and foreign stock taking 15 %, 40 % bond and the remaining 10 % to short term investment that includes money markets and real estate (Rose, 2021) . since the stock is highly volatile, in vesting aggressively in it by allocating its shares that are more than 50 % may lead one losing a large amount of money. Therefore, the risk tolerance is, if I lose 50 % percent of my investment to stock, then I will be left with a sizable amount of investment through my other investments.
Response to 1 st post
Great post, Bryan. Yes, to build long-term wealth, investing in stock is better due to high returns. However, the primary goal of diversifying one's investment is not to maximize returns but to reduce the impact of volatility on your investment portfolio. The stock has the highest risk of volatility. Therefore, putting all money into stock only exposes you to a risk of suffering the most significant loss if the stock market value drops.
Response to 2 nd post
The investment is diversified though putting about 60 percent in stock is an aggressive investment. Having a 60 percentage in stock is a good investment if you want to maximize returns because it can yield up to 136.07 % return, for example, the Don Jones industry Average, but one suffers a fall of the stock value greater risk. During a worst 12-month return, one can incur losses up to 60 percent, which is a higher loss to a person with lower risk tolerance.
References
Hvide, H. K., & Panos, G. A. (2014, January ). Risk tolerance and entrepreneurship. Journal of Financial Economics, 111 (1), 200-223. https://doi.org/10.1016/j.jfineco.2013.06.001
Pirgaip, B., Arslan-Ayaydin, Ö., & BahaKaran, M. (2020, May 1). Do Sukuk provide diversification benefits to conventional bond investors? Evidence from Turkey. Global Finance Journal . https://doi.org/10.1016/j.gfj.2020.100533
Rose, J. (2021, April 05). 7 Smart Ways to Invest $100,000. Good Financial Cents . https://www.goodfinancialcents.com/how-to-invest-100000/
