“Don’t put all your eggs in one basket” is a commonly used phrase during investing; but what does it actually mean? Emphasizing on the importance of investing across different types of assets, industries, and sectors; this golden rule is at the heart of portfolio diversification. For every investor, incorporating portfolio diversification is a vital aspect of investment strategy.
The primary purpose of portfolio diversification is to reduce the risk by not putting all your capital into a single investment or asset. It reduces the investor’s susceptibility to market fluctuations and downturns, allowing them to compensate for any potential losses with other assets. This form of risk mitigation acts as a safety net for all investments, safeguarding your financial future.
There are many other advantages of portfolio diversification. It allows investors to make consistent returns, despite the state of the economy. While fixed-income products would prove to be beneficial during a recession, during an economic boom, stocks in a bull market might be profitable. This allows for capital preservation and lowers the volatility of an investor’s investment portfolio, allowing for long-term growth and flexibility.
An alternative to investing in traditional assets, cryptocurrencies and NFTs (non-fungible tokens) are highly volatile in nature; posing a risk of great profit or major losses. These digitized assets allow for investors to expand into new sectors and geographies, and try something new besides their current stash of securities. Further, tokenized assets of real estate, art, music, collectables, precious metals, and intellectual property can be invested in through NFTs.
Fixed-income products are perfect for investors seeking out stable and reliable income streams. Despite the state of the economy, these products deliver consistent returns, protecting investors from asset devaluation. Examples of fixed-income products include bonds, treasury bills, NSC (national savings certificates), and debt mutual funds amongst others.
Often referred to as a basket of shares, mutual funds contain a myriad of assets such as stocks, bonds, and other securities. They are suitable for investors who want to diversify their portfolio but are unable to buy and sell profitable stocks on a daily basis. Mutual funds provide investors with the opportunity to invest affordably and conveniently in small amounts, as well as tax benefits up to Rs. 1,50,000 under Section 80(C) of the Income Tax Act. Since they are professionally managed by asset management companies, mutual funds also mitigate risk, while leaving room for portfolio diversification.
This involves investing in various instruments that are traded on the BSE (Bombay Stock Exchange) and NSE (National Stock Exchange). These instruments include equities and derivatives. Equities such as stocks, options and futures can be sold on the primary market (through IPOs) or on the secondary market (through the stock exchange). Additionally, derivatives are securities whose price is dependent upon underlying assets. Examples of derivative instruments include options and contracts (either forwards or futures), whose price is dependent on stock price and volatility amongst other factors. Equity instruments are high-risk, high-reward investments; offering investors the chance to facilitate wealth creation.
Fixed deposits is a savings account with a fixed rate of interest. Such accounts are offered by banks, credit societies, NBFCs (non-banking financial institutions), and corporates as well. Fixed deposits are suitable for investors looking for minimal risk, flexible tenures, and easy liquidity. Before an investor embarks on the journey of portfolio diversification, there are a few requirements.
These two accounts are essential for investing. A Demat account is mandatory for registering for IPO shares and is digitally secure for your securities. A trading account is necessary for buying and selling shares on the stock exchange.
An investor should be completely clear about their investment goals and strategies, whether it be for growth, value, or quality investing. This will help narrow down how much and which securities to invest in.
An investor should be completely clear about their investment goals and strategies, whether it be for growth, value, or quality investing. This will help narrow down how much and which securities to invest in.
Financial advisors can provide services like constant monitoring, customised and personalised recommendations, in-depth research and analysis for your portfolio. This can help investors make the right investment decisions, ones that are the most suitable for them.
Portfolio diversification is an inherent investment strategy for experienced investors, and novice investors should follow suit. It is an essential part of portfolio management. The scope of diversification in investing is unlimited, and with the help of a financial advisor, investors can navigate it with ease and finesse. Moneyedge provides 3 different types of portfolio management services (PMS) with a comprehensive network of financial experts and economic authorities. To know more about investing in diverse products, you can write to us at info@moneyedge.co.in or call us at 8699993333.
The diversity of a portfolio can be measured by counting the number of assets and determining the weight of each asset. For example: an investor has 15 assets in the technology sector, 5 in logistics and transportation, and 4 in FMCG. Since the investor has a majority of assets in the tech sector, it can be assigned a weightage of 62.5%. Investors should aim for a more divided percentage across all assets.
Talking about individual assets, mutual funds or index funds are the most diversified since they track various equities, fixed-income instruments, and other commodities. Investors should try incorporating diversified mutual funds in their portfolios.
It is important to assess the effect of diversification on portfolio risk and returns. Using the standard deviation of the return on investment generated, investors can measure portfolio diversification performance and risk. The larger the standard deviation, the riskier the asset.
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