A Portfolio is the summary of all of your Monetary Financial investments like stocks, bonds, commodities, cash, etc. They say a good portfolio should tell a story by itself. It is a passive investment of securities in a portfolio made with the expectation of earning a return.
Diversification is the investment technique that spreads all your investments throughout an array of various prospects and funds. Diversification is done to reduce an investor’s risk and to reduce your chances of experiencing losses. It also smooths out returns and helps improve long-term portfolio performance. Diversification is necessary because investments tend to be volatile from time to time. Adjusting one’s portfolio according to such volatility and market pressures is of utmost necessity for every active investor.
You can diversify your investments in 2 ways: Across Asset Classes and Within asset classes.
Investing across asset classes would mean the type of investing in different kinds of areas like stocks, bonds, real estate, cryptocurrencies, etc. Whereas investing within asset classes is the mode of diversification within a single class of asset for E.g investing in various industries of the share market. Now we shall see how investing within the asset class of stocks works.
Investing within an Asset Class – Stocks
Investors can be reluctant to diversify largely even when it is within the same class of asset, but a good investor knows that putting all eggs in the same basket would mean a higher risk than spreading your funds across industries. Investing Risk can be both active and passive, an investor can never fully gauge or expect an upcoming or probable risk headed towards stock or even an industry as a whole at times.
True portfolio diversification is achieved through selecting and holding a variety of asset classes, rather than individual stock-picking and market-timing. It happens when the asset classes in the portfolio are uncorrelated or negatively correlated.
There are numerous sectors in the Indian market that can be explored while preparing a diversification strategy. Sectors have to be chosen with the investor’s needs and the market growth rate of such sectors in mind before investing.
Investing in bonds across different industries helps an investor significantly reduce the risk of their portfolio. The effect is greater when there is little or no correlation between the industries. Diversifying into stocks that share risk factors doesn’t help you much. Spread out your exposure across companies of different sizes that operate in separate industries.
Strategies for Diversification
1. Invest in index/bond funds
To start off your portfolio, secure your first bit of funds into an index or bond which will rarely fail. This could be a government bond, a unit trust of India fund, or even a fixed deposit. The intention is to secure this small percentage of your funds to always return. Sadly, these kinds of funds even though provide a high level of assurance, do not provide high returns. It would be apt to set aside these funds based on your need.
2. Keep building into your portfolio
Keep the investment clock ticking as you never know how it is going to hand you in the future, just like anything else, Investing too is a skill that is gained through patience, perseverance, and mainly experience. Therefore keep yourself active in building your portfolio and spend some time investing in it on a daily basis.
3. Rebalance your Portfolio regularly
Every single portfolio requires to be rebalanced from time to time. Over time, some investments will win and some will lose them. Rebalancing is a balance between risk and reward which will aid in keeping your portfolio intact and successful during market changes.
4. Ascertain your Risk tolerance
Each investor is different from each other, and might believe in different sentiments. Investors even perceive different information differently. One aspect an investor must consider is the level of risk he/she can tolerate. Investors may be split into Aggressive, Moderate, and Conservative types of investors for this purpose. An Aggressive investor will trade in 100% risky assets such as equity. A moderate investor may maintain an Equity-bond ratio of 7:3 and a Conservative investor may follow a 1:1 ratio.
5. Layering Risk
Every investor must take risks to earn rewards in this market. The smart investor would know how to balance these risks. Time factor plays a major role in risky assets. An asset may be defined for short-term holding or long-term accordingly.
6. Determine Correlation
Defining a correlation to what serves your investing purpose is very important. Correlation statistically measures the degree of relationship between two variables in terms of a number. This strategy involves the use of a correlation matrix.
Diversification must be an integral part of every investor’s plan of investing. Mutual funds can be used as a very important example, mutual funds are comparatively low on risk only because of their excellent diversification strategies.