Remember when your mother kept all her gold ornaments and other precious jewelry in different places? Ever wondered why she is doing that? It's simply to MINIMIZE the risk of loss during a theft.
We live in an uncertain world where anything can happen at any time. So, it's a wise men's call to be prepared for the uncertainty.
What is a Portfolio?
An investor's collection of assets is known as an investment portfolio. Investment securities such as bonds, stocks, mutual funds, pension plans, real estate, and even tangible assets like gold may be included in the portfolio. This refers to any asset
that has the potential to increase in value or yield returns.
What is Portfolio Diversification and its Objectives?
Portfolio diversification is the process of investing your money in different asset classes and securities to minimize the risk of the portfolio. Often people confuse this term with maximizing return. Even though the maximizing return is a secondary thing the primary objective of portfolio diversification is to minimize the unsystematic risk of the portfolio.
Now we have a basic idea of what is a portfolio and what is portfolio diversification. There are also a few things to keep in mind while diversifying your portfolio.
7 THINGS TO KEEP IN MIND DURING PORTFOLIO DIVERSIFICATION
One of the fundamental principles of investing is portfolio diversification, which is essential for better risk management. The advantages of diversification are numerous. However, caution must be exercised. Here are some tips for successfully diversifying your portfolio:
Spread out your investments: Equities can be great for investment, but you shouldn't invest all of your money in a single stock or industry. Consider investing in a few companies that you are familiar with, have faith in the long term, and create your virtual mutual fund.
Consider index funds or bonds: These are fixed income instruments that give you a fixed return on your investments comparatively with lower risk. Consider investing in higher safety rated or investment grade bonds like AAA, AA, A, and BBB to minimize the risk. By including them in your portfolio you achieve diversification benefits.
Keep building your portfolio: Revise your existing portfolio by periodic rebalancing. Add more of an asset class if you get it at a price that'll enhance the value of your overall portfolio. Use a dollar-cost averaging strategy to cut down your investment risk by investing the same amount of money over a period of time. In simple words, buy more when the prices are low and buy fewer when the prices are high.
Know when to take an exit: It is generally observed that investors keep on buying and building their portfolio but fail to plan an exit strategy and when to book profits on their investments. The reason for this is, that not all companies have a forever golden period and over the period of time they may go through business cycles which may affect the share price as well.
Keep an eye on the commissions: When your portfolio is managed by a professional he charges a commission on the return. Sometimes the commission charged may eat a big chunk of your return. So, keep an eye on the commissions charged by your portfolio manager.
Don't over-diversify your portfolio: Diversification is a crucial strategy for the majority of investment portfolios, but the idea can sometimes be overused. To avoid having an overly diversified portfolio, it is important to keep an eye out for overlapping investments since not all investments have the same benefits of diversification.
Don't forget about cash: It's true that cash won't give you any return or protection against inflation but it's a big mistake to undermine the power of cash. The two reasons for holding cash are you can invest in future opportunities and may get protection against uncertainties in your day-to-day life.
The types of asset classes used for portfolio diversification are:
Stocks
Mutual funds
ETFs
Bonds
Cash
There are also alternative asset classes, which include:
Real estate, or REITs
Commodities
International stocks
Emerging markets
Hedge funds (if you are a qualified HNI individual)
General Diversification Rule w.r.t. Age of an Individual
Diversification is important at any age during your lifetime, but there are times when you need to access your risk appetite as per general rules and allocate your money as per your return needs and risk tolerance level. The table below just gives an idea about how to allocate your risk w.r.t age. Here, the rule of thumb is that you should subtract your age from 100 to get the percentage of your portfolio that you should allocate to risky and safe investments. The reason for this allocation is based on the fact that the closer you get to retirement age, the less time you have to bounce back from stock dips. From the table below, risky investments include stocks, hedge funds, small-cap mutual funds, international stocks, emerging markets, etc. and safer investments include bonds, real estate, debentures, ETFs, mutual funds, etc.
S. NO. | Investor Age | Allocation in risky investments | Allocation in safer investments |
|---|---|---|---|
1 | 20 year old investor | 80% | 20% |
2 | 30 year old investor | 70% | 30% |
3 | 40 year old investor | 60% | 40% |
4 | 50 year old investor | 50% | 50% |
5 | 60 year old investor | 40% | 60% |
6 | 70 year old investor | 30% | 70% |
Final Words
Investing is a risky business, so you should never put all of your eggs in one basket. finding the right strategy is crucial, whether it involves concentrating on one asset class and investing heavily in a wide variety of investments within that class or distributing your investments across all asset classes. Both types of investment strategies can aid in lowering the risk while raising the likelihood of rewards, which is the whole point of investing. you should be able to benefit from a well-diversified portfolio if you do your research and adopt the best strategy for your needs.
I personally use "Groww" for maintaining and building my investment portfolio and so far I do not have any complaints against them. This is not sponsored. However, if you are planning to open an account using Groww, you can use my referral link, through it both of us can get ₹100 deposited in our account when you activate your account on Groww. It is a win-win situation. Click here to open an account on Groww.
With this, we have made it to the end of yet another article. I hope you have acquired something new. Consider giving it a like and sharing it among your friends and family. It will motivate me to keep writing new articles for you. To get notified whenever I publish new articles, sign up to the NerdyTree by hitting the "log in" button at the top of the page.
Let me know how you maintain your portfolio in the comments below.