How to diversify your investment portfolio: “Don’t put all eggs in one basket” is standard investment advice that most of us have received if we invest in the stock market. But have you ever thought about the logic behind this practical advice? Yes, it’s all about investment diversification.
In this blog on how to diversify your investment portfolio in India, let’s dig deeper into the topic of diversification to find out why it is done, what are the merits of diversification, how we can diversify our portfolio, to mitigate the risk of losses , and much more. To find out more, keep reading!
Diversification of an investment portfolio refers to investing money in different asset classes like stocks, bonds, mutual funds, etc. in order to maximize the return on investment and reduce the overall risk of losses.
Objective of diversification
The basic concept of diversification is based on the saying of many experienced investors that “Don’t put all your eggs in one basket”, meaning don’t invest all your money in one asset or one asset. only market.
The main objective of diversification is therefore always to obtain a maximum return on investment by offsetting the weakness of one asset class with the other. For example, if you create a diversified portfolio by purchasing stocks, bonds, mutual funds, etc. It is not possible for all asset classes to perform the same over a given period.
If stocks move sideways, this loss can be offset to some extent by good interest on bonds or capital appreciation in gold or real estate.
The main objective of investment diversification is to reduce losses. Here, if one asset generates lower returns, it is compensated by higher returns from another asset that has performed well and ultimately the investor can get good returns.
How is investment diversification done?
Now that we have understood the meaning of diversification, let’s see how it is done with the help of an example.
For example, if you are planning to invest Rs. 2 lakhs, then if you invest all your money in stocks, you cannot expect fixed returns if you are a defensive investor (the person who does not want to take risk), then you risk losing money in stocks if the market falls.
On the other hand, if you invest only in debt securities such as bonds, you may only receive fixed returns, comparatively lower than what people might earn when the stock market is bullish.
Thus, all asset classes have some or other limitations that can lead to losses for investors in the event of market volatility. But if you invest the same money in different asset classes, although you cannot completely avoid losses, you can significantly reduce them.
Types of Asset Classes Used for Investment Portfolio Diversification in India
Now let’s take a look at the different asset classes to know how to diversify your investment portfolio.
Equity: These are shares of public limited companies listed on the stock exchange and freely traded on the stock market.
For example, you can buy shares of any Nifty 50 company like TCS, Wipro, Infosys, Reliance, etc. if you are a risk-averse investor… or you can buy other stocks of growing companies if you have a higher risk appetite. .
Obligations: These are long-term debt securities that earn a fixed return on investment in the form of interest. Bonds include government bonds and fixed-income corporate debt securities.
You can buy any bond like government bonds or corporate debt bonds like Triple A rated corporate bonds rated by agencies like Moodys, government bonds like RBI bonds, bonds sovereigns in gold, etc.
Exchange Traded Funds (ETFs): ETFs are a collective group of tradable securities that track publicly traded commodities, indices or sectors.
You can buy any SEBI registered ETF of any sector like Index ETFs, Gold ETFs, Bond ETFs, Currency ETFs, Sector ETFs and Global Index ETFs like SBI Sensex ETFs, ETFs HDFC Gold, etc.
Products: These are goods that can be traded worldwide on any market and regulated by an authorized commodities exchange. These products include natural resources and agricultural products. You can buy publicly traded commodities like silver, food grains, crude oil, etc.
Real estate and properties: They include physical properties such as land, buildings, livestock, etc.
Species: The cash asset class includes most money market instruments such as certificates of deposit, treasury bills, etc.
Gold: Gold investment is a typical secular asset class used in India for long term investment and capital appreciation.
Mutual fund : A mutual fund is a pool of investments collected from a large number of investors to invest their money in different types of financial assets such as stocks, bonds, etc.
It is the best option for investors who do not have the knowledge or time to actively invest in the stock market. The funds are wisely invested in various asset classes on the advice of the fund managers. There are different categories of mutual funds like blue chip mutual funds, index mutual funds, small cap mutual funds, etc.
There are many customized investment options available in mutual funds to diversify the portfolio, such as Axis Bank Bluechip Fund, SBI Small Cap Funds, HDFC Multi-Asset Funds, etc.
Importance of diversifying the portfolio for investors
- Minimizes the risk of market volatility
When you invest in different asset classes, the loss of one is offset by the profit of the other. Ultimately, the overall risk of the portfolio is therefore reduced.
- Optimal use of the merits of all asset classes
As we discussed earlier, each of the asset classes has its own advantages and disadvantages. But by combining them all into one portfolio and reducing overall risk, the investor can take advantage of the individual merits of all asset classes.
For example, if we have stocks, bonds and mutual funds in our portfolio, then we can enjoy the interest income from bonds as well as the benefit of compounding our money in mutual funds.
Key points when diversifying your portfolio
The first thing to consider when building a portfolio is to define your investment objectives, as these are essential in deciding the mix of different asset types in your portfolio. The returns you earn also depend on your goals. If you are a risk-averse investor, you may earn less fixed income. On the contrary, if you are a risk-taking investor, you could also earn a higher return associated with higher risks.
For example, if you are able to leave your money uninterrupted for a long period of time, you can focus on high-yielding long-term investments like mutual fund SIPs. On the other hand, if you are a risk-averse investor, you can invest more in bonds.
- Good diversification between asset classes
It is important to diversify your portfolio with an appropriate mix of different types of assets like stocks, bonds, ETFs, etc. based on your investment objectives to distribute risk evenly across all assets to reduce the overall risk of a portfolio.
For example, if you can only take risk on a certain percentage, perhaps 60% of your money, then you can diversify your portfolio in the following way (this is not a recommendation):
Bonds and other risk-free investments (such as term deposits): 40%
Mutual funds: 15%
Real estate: 10%
In this particular example, you can get fixed returns from 40% of your investment through interest from bonds and FDs. Returns on the remaining 60% of your income may be subject to market risks and continue to fluctuate.
- Increased diversification within each asset class
To get the best returns on your investment, it is important to invest wisely. This means that within each asset class, you need to diversify further to reap the maximum benefits.
For example, within stocks, diversify your fund across various sectors like IT, pharmaceuticals, FMCG, etc. Still within mutual funds, you can invest in different programs.
- Invest professionally with the help of the fund manager
It is always best to seek professional advice if you are not an expert in a particular area. When it comes to investments, a qualified fund manager can definitely help you get the most out of your investments.
In this blog on how to diversify your investment portfolio in India, we have discussed in detail everything related to diversification, right from its meaning, importance and the diversification options available to investors. Hope this adds value to your investment journey. That’s all for this blog. Good investment!
Written by Bhagyalakshmi Patil
Using the stock screener, inventory heatmap, portfolio backtestAnd compare stocks On the Trade Brains portal, investors have access to comprehensive tools that allow them to identify the best stocks and are also updated with stock market newsand make informed investment decisions.
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