Diversification is the only free lunch in finance. Other forms of risk reduction exact a price in expected return, but diversification leaves expected return unchanged while lowering volatility- Opines Hirav Shah, Famed Entrepreneur, Business Advisor, Business Strategist and Prolific Business Transformation Expert.

However, it’s important to diversify in terms of factors, not securities. You can buy a lot of different stocks without getting as much diversification as an investment in a different asset class.

In fact, simple proliferation of positions can be ineffective for diversification, and it tends to increase costs, push you into second-best choices and reduce your attention to each position.

Elucidation:

The whole idea of diversification is to allocate your funds to different asset classes which are not perfectly co related, non correlated or negatively co related to each other.

By doing so, one avoids over exposure to a particular asset type and reduces the overall risk and volatility on his portfolio, as all his investments will not rise and fall in tandem. To the same market situation, they will react differently.

Let us take a simple example of a portfolio invested 50 % in equity, 40 % in debt and 10 % in gold. In March last year, when the India stock markets crashed triggered primarily by the covid pandemic, the equity part must have lost about 25–30 % , but at the same time, medium to long term debt funds gave superior returns due to the falling interest rates, and Gold outshone.

Hence the notional loss on the equity part was offset at least to some extent by the debt and Gold part.

If you intend to diversify your investment portfolio, you must focus on reducing your overall investment risk by spreading your corpus across different asset classes. You need the right mix of defensive and growth assets.

Investments such as cash or fixed interest deposits qualify as defensive assets. Such investments provide a lower return over the long term. However, they also come with a low level of volatility and risk.

Investments such as shares or property that generally provide more capital gains over a longer term are called growth assets. Although these investments are lucrative, they typically have a high level of risk since the return on such investments is largely dependent on market fluctuations.

Diversifying Investments:

To build a diversified portfolio, you should aim to spread the investment risk across different asset classes. Keep some of your funds in fixed income investments (like bank FDs, PPF, debt funds), some in the share market, and some in properties.

Within each of these asset classes, diversify your money even further. For instance, if you’re purchasing shares, then do so across different industry sectors.

If you’re investing in managed funds, make sure to spread it across different fund managers. No investment can consistently outperform other investments. Different types of investment perform in different ways owing to a range of factors like:

  • current market conditions
  • interest rates
  • currency markets.

For instance, your share portfolio may suffer losses during periods of increased share market volatility. If you simultaneously hold investments in other asset classes, such investments may perform better during the same period.

Moreover, the returns from safe and steadily growing investments like Fixed Deposits, Post Office Monthly Income Schemes, Public Provident Fund, etc. can help mitigate the losses. Thus, diversified investments can keep the returns of your overall investment portfolio smooth and steady.

Final Thoughts

Rock all your investments in 2022. Organize, discuss, and get things done this year. Diversify !!- Hirav Shah, India’s Premier Business Enhancement Expert Concludes…