Are we doing diversification wrongly? We may think that we are well-diversified when in actual fact we are still concentrated largely in one area or type of investment. Why should we even practice diversification in the first place, wouldn’t it dilute our returns on the good investments?

(Source: flickr.com, Simon Cunningham)

Diversifying is useful in reducing the overall risk of our portfolio. By spreading our capital over more investments that do not correlate 100% with each other, we increase the chance that our capital will be affected by a downturn in the particular company or industry. It helps us reduce our risk to the undiversifiable risk, which is that of the market as a whole or maybe even less if we use invest in other instruments like bonds.

An example, let’s say that there are two companies, one that makes money when it is raining and another that makes money …