Posted on September 27, 2009 by Nayab Naseer

The traditional adage goes “Do not put all the eggs in one basket.” This holds true for investing also. The smart investor never invests all his or her wealth in one avenue or instrument, for no matter the effort and knowledge that goes into an investment decision, many things beyond the scope of anyone’s control can go wrong, putting the earnings projection or even the invested capital in peril.

It is therefore essential to diversify investments into several classes. However, too much of diversification is also bad. The extent of diversification should ideally depend on the amount available to invest. To provide an allegory, if a cloth is thin, stretching it too far will cause the cloth to tear. Spreading investments too wide would mean the investment in one sector being too negligible to attract meaningful returns.

The optimal ratio or amount to investment in different categories, and the areas of investment depends on individual circumstance, to be made by the individual investor after considering his or her specific circumstance.