Consider this: On the first day of June, 1968 a man sets out to sell 27 air conditioning units. He successfully sells all 27. But he doesn’t stop there. He instead goes on to add refrigerators, freezers, microwaves, and continues to expand his product range until the company grows into a multimillion dollar empire.

This company is Appliance Traders Ltd and this man is Gordon “Butch” Stewart. What, among many things Mr Stewart did right, was to diversify his product range.

Diversification is the practice of spreading money among different investments in order to maximise returns and mitigate risk.

Simply put: don’t put all your eggs, or in this case money, in one basket. This is one of the most important strategies one should use when deciding how to invest. In fact, it is one of the most basic building blocks of a good investment portfolio.

Choosing the right group of investments may limit your losses and reduce the dramatic changes in investment returns without sacrificing too much potential returns.

How you diversify your portfolio depends on three things: your investment goal, risk tolerance and time horizon.

Your investment goal is your primary reason for investing while your time horizon is the time it takes you to reach that financial or investment goal. Your risk tolerance is how able and/or willing you are to lose your investment capital in exchange for the potential to accumulate high returns.

Here’s an example of how these three work in tandem: 20-year-old Mary Brown would like to start planning towards her retirement. She would like to retire at 60 so therefore her time horizon is 40 years. Because Mary has a financial goal with a long-time horizon, she is likely to make more money by carefully investing in asset categories with greater risk, like stocks, rather than restricting her investments to assets with less risk, like bonds. This is the kind of information investors use to decide how to allocate your investment capital.

You should consider diversifying your portfolio not just between asset categories but within asset categories as well, remembering your time horizon, risk tolerance and overall financial goal. So in addition to allocating your investments among stocks, bonds, mutual funds and other asset categories, you’ll also need to spread out your investments to include a number of different stocks, different bonds, and so on.

Among other things, one major benefit of creating a diversified portfolio is that the combination of many different investments tends to have varying patterns of returns. Diversifying also helps avoid extreme overall results to your portfolio should any one asset category experience a long period of poor performance. The key is to identify investments in segments of each asset category that may perform differently under different market conditions.

One way of diversifying your investments within an asset category is to identify and invest in a wide range of companies and industry sectors.

On the Jamaica Stock Exchange there are stocks listed in the manufacturing sector, finance sector, retail sector and more.

Here’s an example of how not diversifying can put your portfolio value at risk: Let’s say you have a portfolio of stocks only in the health sector. If it is then announced publicly that there is a major defect in one of their machines that was missed during production, and if this defect has serious implications for the health of the people that have used them then share prices of these stocks are likely to drop. You will then notice the impact of this drop in the value of your portfolio.

If, however, you diversified your portfolio to include not only stocks in the health sector but also some stocks in the finance sector, then only part of your portfolio would be affected by this decrease. Remember, you want to diversify across the board, that is, invest not only in different types of companies but also different types of industries. The less your stocks relate, the better.

Diversification, though challenging, can be a rewarding strategy if done the right way. If you have any doubts it’s always a good idea to consult a knowledgeable investment agent from a reputable investment firm.

Remember, however, that though diversification can help to mitigate some of the risks associated with investing, it can never eliminate it completely. The key is to find a happy medium between risk and return that will ensure you achieve your financial goals.

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nya Mollison is a Service Associate at Stocks and Securities Ltd.