Remember the chapter of Balanced diet in your school days? It’s useful to keep the mind and body strong and healthy; adequately diversified investments help in keeping your investment portfolio strong and healthy.
What Is Diversification?
Diversification is the practice of spreading your investments across financial instruments, industries, geographies, and time horizons so that your exposure to any one type of asset is limited. This practice is designed to help reduce the volatility of your investment portfolio over time.
Why should you diversify your investment portfolio?
Diversification helps to mitigate the volatility and risk in your portfolio. It reduces the potential severity of stomach-churning ups and downs in the portfolio. Different asset classes perform at different times, hence it makes sense to be present across asset classes at all times. This is due to two reasons. One, you don’t know which asset class will perform at what time so it’s advantageous to be present across them. Two, when you are present across asset classes, you have protected yourself from the potential downside of a particular asset class. In investments, downside protection is extremely important for long-term portfolio growth. Downside protection helps you protect your capital thereby employing higher capital towards the potential increase in the different asset classes.
How should you diversify?
You can diversify your investments by investing across the following asset classes and financial instruments-
Equity - You can invest in good quality Equity Mutual funds based on your risk profile and time horizon. Mutual funds are an excellent way to diversify your investments across companies and sectors. It also provides you professional management at a very efficient cost. Investment in Equity mutual funds should be done with a minimum investment horizon of five years.
Debt - You can invest in good quality Debt Mutual funds based on the quality of the papers held by the mutual fund scheme and your investment horizon for investment. The Securities and Exchanges Board of India ( generally referred to as SEBI - the regulator for the securities market in India owned by the Government of India ) has rationalized the mutual fund categories and laid down the specific mandate under each sub-category for both Equity and Debt. This can help you to choose the scheme whose investment duration matches with your investment horizon. This will help you provide stability in your investment portfolio.
Gold - You will be surprised to know that mutual funds also have gold as the underlying investment! Yes, you can have exposure to gold as an investment asset class in your portfolio through mutual funds. You simply need to invest in a mutual fund scheme that has gold as the underlying. Of course, you won’t be able to enjoy the touch and feel of this precious metal, but you will surely be able to enjoy the price differential.
Exchange-traded funds (ETFs) - An ETF is a marketable basket of securities that follow an index, commodity, or sector. You can take exposure to commodities in your portfolio by choosing to invest in an ETF that tracks commodities.
Geographical Diversification - You can also diversify your investments across different countries through the mutual fund route. Interesting! Isn’t it? Yes, it’s true. There is a sub-category in Equity mutual funds termed as International. The schemes under this sub-category invest in companies across the globe or simply mimic the Index of some other country, say Nasdaq 100 of the U.S. This is an excellent way to diversify your investments across different geographies simply sitting in India. Now you need not only pay for the expensive iPhone, but you can also participate in Apple’s earnings too!
Real Estate - You can also invest in Real Estate once you build up a sizeable portfolio. Direct investment in Real Estate is recommended only after one has built up a sizeable portfolio and looking for simply diversifying the portfolio to spread across the risk. This is due to the fact that real estate is a big-ticket investment, and a wrong investment here can drain the portfolio and lock-up a sizeable portion of your investment portfolio. Although Real Estate Investment Trusts ( REITs ) is a better way to take exposure to this high quantum asset class, currently it is at a very nascent stage in India. A REIT functions almost like a mutual fund does, providing you access to real estate as an asset with professional management small funds.
Cash - You can also have some funds parked in some Flexi-deposit scheme or short-term fixed deposits in your bank so as to tap them at the time of emergency.
Conclusion
Remember, diversification does not ensure a profit or guarantee against a loss. Its primary goal is to limit the impact of volatility on a portfolio. After the entire process, it is still possible to lose some money when you invest. After all, it is not possible to eliminate risk completely. However, adequate diversification helps you to lower the risk of losses in the market to the minimum possible. You have to try to find a good balance between risk and return so that you can earn good risk-adjusted returns without worrying constantly about your portfolio.