Chapter: 11 Principles of Portfolio Management

Section: 2 Why Invest in a Portfolio?

Investing in various industries and instruments can eliminate the unsystematic risk of the total investment. In other words, risks attached to a particular industry and instrument, can be avoided by a well-diversified portfolio. Unsystematic risk, sometimes known as diversifiable can be diversified away. The risk is inherent to the nature of business in the particular industry.


For instance, during a serious economic downturn, luxury products may not be in demand and thus the companies operating in this industry would suffer from declining sales whereas inferior products would witness a growing sales and profits. If a portfolio has investments in both sectors, the portfolio return will not be affected by the particular risk of industries.  Similarly, when a portfolio comprises stocks and fixed income securities, the specific risk attached to the individual investment is diversified to a greater extent.