How To Diversify Your Investment Portfolio: “Don’t put all the eggs in one basket” is a piece of standard investment advice most of us have received if we are investing in the stock market. But have you ever thought of what is the logic behind this advice in the practical sense? Yes, it is all about the diversification of investments.
In this blog on how to diversify your investment portfolio in India let us dig deeper into the topic of diversification to find out why it is done, what the merits of diversification are, how we can diversify our portfolio, to mitigate the risk of losses, and many more. To know more, keep reading!
Meaning
Diversification of an investment portfolio refers to investing money into different asset classes like shares, bonds, mutual funds, etc. to maximise the return on investments and to reduce the overall risk of losses.
Purpose of Diversification
The basic concept of diversification lies in the saying of many experienced investors that is “Don’t put all the eggs in one basket”, which means do not invest all your money in any single asset or in a single market.
Hence the main purpose of diversification is always to earn maximum returns on investments by compensating the weakness of one asset class with the other. For example, if you create a diversified portfolio by purchasing equities, bonds, mutual funds, etc. It is not possible that all asset classes may perform the same during a particular period.
If equities are moving sideways then that loss may be compensated to some extent by good interest on bonds, or capital appreciation on gold or real estate.
The major purpose of diversifying investments is to reduce losses. Here if any one asset yields lower returns it is compensated by higher yields from another asset that has performed well and ultimately the investor can earn good returns in the end.
How is the Diversification of investments done?
Now that we have understood the meaning of diversification let us know how it is done with the help of an example.
For example, if you are planning to invest Rs. 2 lakhs then if you put all the money into stocks you cannot expect fixed returns if you are a defensive investor ( the person who doesn’t want to take the risk), then you may lose money in equity if the market falls down.
On the other hand, if you invest only in debt instruments like bonds you may end up receiving only fixed returns which is comparatively less than what people might earn when the equity market is bullish.
Thus, all the classes of assets have some or the other limitations that may lead to losses for investors in the case of volatile markets. But if you put the same money into different asset classes, even though you cannot avoid the losses completely you can reduce the losses considerably.
Types of Asset Classes Used For Diversification Of Investment Portfolio in India
Now let us see what are the various asset classes to find out how to diversify your investment portfolio.
Equity: They are shares of Public limited companies that are listed on the stock exchange and are freely traded in the share 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 any other shares of growth companies if you have a higher appetite for risk.
Bonds: They are long-term debt securities that yield a fixed return on investments in the form of interest. Bonds include Government bonds and fixed-income corporate debt instruments.
You can buy any of the bonds like government bonds or corporate debt bonds like Triple A Rated corporate bonds rated by agencies like Moodys, Government bonds like RBI Bonds, Sovereign Gold Bonds, etc.
Exchange Traded Funds (ETFs): ETFs are a collective group of marketable securities that follow commodities, indices, or sectors that are listed on the stock exchanges.
You can buy any SEBI-registered ETFs of all sectors like Index ETFs, Gold ETFs, Bond ETFs, Currency ETFs, sector-wise ETFs, and Global Index ETFs like SBI Sensex ETFs, HDFC Gold ETFs, etc.
Commodities: They are goods that can be traded across the world on any market and regulated by authorized commodities exchange. These commodities include natural resources and Agricultural products. You can buy commodities that are listed on Stock exchanges like silver, food grains, crude oil, etc.
Real Estates and Properties: They include physical properties such as land, buildings, livestock, etc.
Cash: The asset class of cash includes most of the money market instruments such as Certificates of Deposit, Treasury Bills, etc.
Gold: Investment in Gold is a typical age-old asset class used in India for long-term investment and capital appreciation.
Mutual Funds: A mutual fund is a pool of investment 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 don’t have the knowledge or time for investing actively in the stock market. The funds are wisely invested in various asset classes on the advice of fund managers. There are various categories of mutual funds like bluechip mutual funds, index mutual funds, small-cap mutual funds, etc.
There are plenty of 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 compensated by the profit of another. Hence in the end the overall risk of the portfolio is reduced.
- Optimum utilization of merits of all the asset classes
As we have discussed earlier each of the asset classes has its own merit and demerit. But by combining all of them in a single portfolio along with reducing the overall risk the investor can enjoy the individual merits of all the asset classes.
For example, if we have equities, bonds, and mutual funds in our portfolio then we can enjoy interest income from bonds as well as the benefit of compounding our money from mutual funds.
Key Points while Diversifying Your Portfolio
The first thing to consider while building a portfolio is to define your investment goals because it is essential in deciding the combination of different types of assets in your portfolio. The returns you earn are also based on your goals. If you are a risk-averse investor, you might earn a less fixed income, on the contrary, if you are a risk-taking investor you might earn a higher return associated with higher risks also
For example, if you are able to leave your money uninterrupted for a long period 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.
- Proper diversification among the Asset classes
It is important to diversify your portfolio with a proper combination of different types of assets like equities, bonds, ETFs, etc according to your investment goals to spread the risk evenly across all the assets to reduce the overall risk of a portfolio.
For example, if you can take risk only on some percent, maybe 60% of your money then you may diversify your portfolio in the following way (Not a Recommendation)
Equities: 15%
Bonds and other risk-free investments (like Fixed Deposits): 40%
Mutual funds: 15%
ETFs: 10%
Real estate: 10%
Gold: 10%
In this particular example, you can earn fixed returns from 40% of your investment through interest from bonds and FDs. The returns on the remaining 60% of your income may be subjected to market risks and keep fluctuating.
- Further diversification within each of the asset class
To earn the best returns on your investments it is important to invest smartly. It means within each asset class you have to diversify further to reap the maximum benefits.
For example, within equity diversify your fund across various sectors like IT, Pharma, FMCG, etc. Again within mutual funds, you can invest in different schemes
- Invest professionally with the help of the Fund Manager
It is always better to seek professional advice if you are not an expert in any particular field. With respect to investments, a skilled fund manager can definitely help you in earning maximum returns from your investments.
Closing Thoughts
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 diversification options available for investors. I hope this adds value to your investment journey. That’s it for this blog. Happy investing!
Written By Bhagyalakshmi Patil
By utilizing the stock screener, stock heatmap, portfolio backtesting, and stock compare tool on the Trade Brains portal, investors gain access to comprehensive tools that enable them to identify the best stocks also get updated with stock market news, and make well-informed investment decisions.
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