Investment &Portfolio Diversification
The famous phrase “Never put all your eggs in one basket” holds very true in case of your investments too. Portfolio diversification is a tool or a technique that helps you minimize your risk by investing in different schemes and plans.
It’s just like if you put all your eggs in one basket and if it drops, you may lose all of them. Similarly, if you invest all your savings in a particular plan or scheme and in case the market goes down you are bound to loose your precious money.
What works behind diversification of funds is the rational that those who diversify their investments earn, on an average, higher returns thereby reducing investment risks. Thus, it is always advisable to scatter your investments so as to avoid being hit adversely. Diversification helps you remain shock-proof - if one plan fails at least you have the other to save you from the blow.
Undiversifiable and Diversifiable Risks
Undiversifiable Risk – These are risks that cannot be eliminated through diversification as they are caused by factors like inflation, political instability, war etc. These are risks that an investor cannot overcome or reduce.
Diversifiable Risk – These risks can be reduced or eliminated by using the technique of diversification of funds. In order to avoid these risks it is important to choose different funds so that market lows and highs do not affect all of them in the same manner.
How to Diversify Your Portfolio
- Investment Plan – Before you go around for any kind of investment it is important for you to have an investment plan that includes the tenure for investment, the minimum amount, returns expected and the mode of payment and return i.e monthly, quarterly, half-yearly or yearly.
- Choose different Investments of low correlation- Correlation means the relationship between two schemes or plans. In simple words it means the interdependence of schemes in your portfolio. This means that you need to choose your investments that go up and come down at different times. This helps you to sail comfortably through the bulls and bears of the market.
- Monitoring – It is mandatory for you to keep a close watch over your assets and keep rebalancing and monitoring your portfolio. The work of portfolio diversification does not end by simply selecting different options. It extends to rebalancing your portfolio by selling and buying.
- Stay invested and watch out for new opportunities – It is important for you to keep yourself invested for a longer duration in order to reap good returns and also keep a close watch on the new opportunities coming your way. Search for new investments and get rid of the non-profitable chunk.
- Investment Principles Work – Invest by following the investment principles. Merely going by predictions may land you in deep waters as no one can accurately predict the future. Create a quality portfolio and avoid being solely carried away by predictions.
Where To Invest – As stated earlier, it is very important to ensure that your investments are spread across different schemes and plans. Correlation can particularly prove beneficial while you diversify your portfolio.
There are many such examples that can guide you through while you invest in different plans. One such example is that of equity and debt. It is worth noticing that equity and debt have a correlation. It is seen that whenever there is a rise in interest rates the earning from debt plans grow significantly whereas returns from equity investments drop. So while you see that the interest is on a hike it goes without saying that those who have more of debt in their portfolio will benefit more in comparison to those who have less debt and vice versa happens when interest rates go down. Here, if you have a diversified portfolio it will work well for you. Moreover, the high rated debt instruments come handy with almost zero risk.
It is always advisable to create a combination of defensive stocks and high beta stocks in your portfolio. High beta stocks are ones that will fetch you a good growth when the market is at a rise but may become a pain for you during market slumps. They reap good but come with a considerable high risk. Stocks like that of FMCG and Pharmaceuticals are defensive stocks and trends show that they have been consistent with their performance in the market even when stock market has not been at its best. So using a combination of defensive stocks with high beta stocks may work well for those who like playing in equity.
Those of you who have bought two mutual fund plans and feel you have diversified your portfolio; it is time for a reality check. This assumption does not hold well if you feel that selecting and investing in different schemes of mutual fund would lead to diversification of portfolio. What will you do if you opt for two different mutual fund plans that have number of common factors between them? Always look out for schemes which are well diversified in the same category.
Assets like gold work in the interest of diversification of portfolio. It goes without saying that gold yields good returns even in hours of crisis. It is advisable to hold gold in your portfolio. Moreover, it shares a negative relation with debt and equity thus acting as asset for you when debt and equity both suffer a hit.
It is important for you to understand that having a big portfolio will not help. It is important to balance it out with right choices. If you want to draw best from your portfolio make sure you follow the rule of correlation while creating your portfolio.
Save yourself from Over-Diversification – It is very important to strike equilibrium in case of diversifying your portfolio. In order to create a diversified portfolio do not get so much carried away that you end up investing in too many assets, schemes and plans. You should not spread your money so thin that all the effort goes in vain. Over diversification may shield you from great losses but it would surely lead you to losing good gains. So while you create your diversified portfolio do keep in mind that you need to strike the right balance without over indulgence as too many cooks spoil the broth.
Contributed By: Megha Sharma |
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Megha Sharma works as a guest lecturer in Delhi. She holds an MBA & Doctorate from the UPTU. With extensive knowledge and experience in various financial products, she also works as a consultant in banking & finance domains wherein she offers advice to her clients in managing personal finance. | |
