You might have heard the proverb “Don’t put all your eggs in one basket”. It is the same with investing. Investing all your capital in one place, for example, a particular stock might align the fate of your portfolio with the performance of the stock. Any sudden discrepancy in the company can lead to significant losses.
Forbes Advisor calls diversification the “key to intelligent investing”. Diversifying one’s investment portfolio can reduce risk as the resources are spread across multiple asset classes, regions and industries. The benefit of a diversified portfolio is that it isolates the exposure of one investment from the other investments in the portfolio. Hence, if an investment performs poorly, doesn’t result in the whole portfolio performing poorly as the investment is diversified and the element of risk is minimized.
Here are ways to diversify an investment portfolio:
1. Choose different Asset Classes – Spreading investments across a range of asset classes like stocks, commodities, and real estate will reduce the risk of being tied to the fate of one asset class. It will also protect your portfolio against the volatility in the value of a particular asset.
2. Investing in different Industries – Industry diversification is equally important as market volatility tends to impact sectors collectively. Unless the particular company has high relative strength, the company will be impacted by the direction of the sector. Diversifying resources in different industries will reduce the risk against market sentiments and factors of one sector harming your portfolio.
3. Investing across Geographies – Investing across regions is an alternative to consider with questions such as the political and economic stability of the region. Investing across different regions can shield your portfolio from the economic performance of a particular region and also keep avenues open to moving investments in case a particular region is in recession.
4. Benefit of Exchange Traded Funds (ETF) – ETFs are an easy alternative to curating a diversified portfolio. ETFs are created by including indices of different asset classes and industries to create a balance diversified fund. Tracking the stocks in an ETF is easier but the research on the criteria for the creation and the sectors of ETF as well as exposure to different Industries is important.
5. Investing in Market Indexes – Indexes are a relatively safer option as the index is the gauge of the market itself. In the case of the Nifty 50, it consists of 50 blue-chip companies from different sectors and industries. The Nifty 50 has surged 68.26% in the past 5 years.
6. Update your Portfolio’s Balance – Timely updates to the investment portfolio are important to assess the performance of different investments and make changes accordingly. It can include the sale of investments on reaching targets, cutting underperforming investments, adjusting investments according to risk-taking capacity and checking if investments are in line with financial goals.
7. Keeping a Cash Reserve – Keeping a cash reserve can help you in the emergency requirement of funds and not have to withdraw from your investments. If you trade in the derivative sector, the cash reserve is essential to keep positions open in case of an unfavourable move. Reserve cash can also allow for better averaging of investments over time.
Can a portfolio be over-diversified?
The answer is yes. To avoid over-diversification of your portfolio, avoid overlapping investments such as stocks and funds in a particular sector. Diversification for the sake of it, without taking into account the cost involved in it, for example extremely high brokerage fees for overseas transactions will cost more than benefit you.
A good strategy for diversification of a portfolio can be balancing it with uncorrelated assets so that each investment remains stand-alone from the other.
*Disclaimer: This content piece is for informational purposes only. Recommendations, suggestions, views, opinions, scores, research and investment tips expressed herein are not that of Vygr (Vygr Media Private Limited or its management and has been gathered from various third-party sources. Vygr/VMPL does not guarantee the accuracy, adequacy or completeness of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. The content provided herein should not be relied upon or construed as an investment advice or recommendation or opinion. Please note that all markets have inherent risks. Furthermore, risk appetite is a personal aspect and varies from individual to individual. Vygr is not licensed to advice or recommend investments. Vygr advises users to check with certified (Licensed and Registered intermediaries) experts before taking any investment decision.
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