Situations Where Investors Do Not Diversify Assignment

Situations Where Investors Do Not Diversify - Assignment Example A diversified portfolio of investments, however, facilitates, distributing the risk factors across a number of securities issued by different firms. Therefore, if there are losses earned on a particular stock, it can be easily compensated by the profits earned on other stocks (Medo, Yeung & Zhang 2009). Investors are seen to diversify their portfolio by including not only common stock but also bonds and cash. Investing in stock is considered to be less risk induced than investing in debt securities. However, investments in stock do not yield fixed rates of return. The returns obtained from stock or the dividend earned depends upon the residual earnings of the firm. If a firm’s profits are high, it is likely that the returns are high. Since organizations operate in a complex business environment, it is difficult to predict the profits earned by a firm accurately. Considering such factors, investors find it risky to invest in common stock only (Loutskina & Strahan, 2011). Most i nvestors prefer including debt and other forms of borrowings in their portfolio. The advantage of including debt securities is that it facilitates fixed rates of returns. Investments made in cash are usually considered as a short-term reserve. Such investments can be liquidated easily. Usually, investors are seen to invest in money market securities so that they can be used in the state of emergencies. It is also important to understand that asset allocation and portfolio diversification are closely related. A diversified portfolio gets created through the allocation of assets (Goldstein & Pauzner, 2004). Diversification is required to be planned and approached with caution. Investors are normally seen to refrain from having a diversified portfolio during times when the market is highly volatile and there are risks associated with liquidity. Under such circumstances, investors avoid investing in debt and prefer common stock only. Hence, there is no limited diversification.