A pie chart or a diagram representation with different percentage pieces- That’s the perfect picture we have in our mind for the word – Diversification ! right…? Diversification in simple words is nothing but – “a blend of different asset classes” to minimize the risk of a portfolio.

But people often misunderstand the concept of diversification. Let’s see what people misunderstand about diversification:

• Diversification is a tool to minimize the risk. It does not increase your profit. As rightly said by someone- “In investing, getting high returns is not the only factor, it’s equally important to avoid losses” and diversification helps to minimize the loss.
• Diversification is not simple like- having a mutual fund or stock portfolio with 1 large cap, 1 mid-cap, 1 small cap. It’s more about right correlation between different asset classes.
• Diversification is more concentrated on co-relation of assets. It’s not about having a bunch of assets in a portfolio but about holding the assets with low correlation to each other.
• Too many funds or too many different stocks does not make a diversified portfolio. Portfolio with too many stocks/mutual funds could be over-diversified, risky and concentrated.
• Similarly, having investments in all asset classes like debt, equity, gold, real estate, cash does not means your investment portfolio is diversified. Diversification depends on investor’s risk, goal, age, duration of investment etc.
• Asset allocation and diversification is not same. Asset allocation is about having investments in various asset class like equity, debt, real estate, gold, commodity etc. While diversification is about number of such assets in your portfolio. Asset allocation is a technique in which assets are allocated within your portfolio to align with your financial goals and objectives.
• Diversification does not fail- This is one of the common myth that diversification strategy is risk-proof and does not fail.  However, one can not predict that how asset classes will perform like stocks, bonds etc. It all depends on predications and these predications are based on past performances, market movements, economic/political news etc.
• Investing in Index fund means being diversified is a myth.- Index funds represents just a part of stock market and not entire stock market. Also, Index investing does not mean you are holding a diversified portfolio as index funds replicates the index and there could be more same type of stocks like large cap stocks or index funds which follows the strategy of value investing, growth etc.

Diversify your portfolio not just by holding different asset classes but also by each asset class.

• Diversify your Stocks portfolio through investing in various sectors like banking, IT, Pharma with small, mid and large cap stocks.
• Diversify your Interest instruments on the basis of maturity dates, interest rates and tax treatments.
• Gold is an investment which has almost negative correlation with stocks.
• Cash carries a zero correlation with almost each asset class. Therefore, holding it can save you in diminishing markets.

Remember, to choose asset classes according to your goals, age, savings and available time. It will certainly help you achieve your goals.

Note:Above article is based on one of my Quora answer.