Diversification is a crucial aspect of portfolio management. Diversification encourages investors to spread their investments across various asset classes. It minimizes risk and protects against volatility. Besides, it also helps in building an efficient strategy to grow wealth.
Don’t put all your eggs in one basket: This term very well captures all the essence of diversification. It encourages investors to spread their exposure to the different types of assets. When the volatility increases in one asset, your other investments provide stability.
How to Diversify?
Portfolio diversification is crucial for better risk management. It can be achieved by allocating funds to different asset classes.
Here are the investment options to achieve better diversification and proper fund allocation.
Historically, equities usually outperform other asset classes. This asset class is simple and easy to understand. Besides, it is suitable for investors with a longer investment horizon.
There are options for everyone. Within equity, investors can diversify their portfolio among the large, mid, and small-cap stocks. Aggressive investors can also add foreign stocks to their portfolios. There are also ETFs that provide stable long-term returns at a low cost.
To protect against volatility, investors should invest in a diversified portfolio of stocks. This requires a lot of attention, work, and careful tracking of company updates. A Registered Investment Advisor (like Teji Mandi) helps investors who are new or don’t have time to track the market.
These advisors are SEBI regulated and have a dedicated team for comprehensive analysis of the portfolio.
Read our article on allocation strategies here
Read about our portfolio strategy here
2) Fixed Income Instruments
Investment in bonds provides fixed income and they are usually non-volatile. These instruments are safe and ideal for people looking for a steady source of income. But, they are usually not helpful in the long-term to create wealth.
Investors have options like bank fixed deposits, government bonds, and Non-convertible debentures (NCD). NCDs are risky, but give higher returns in comparison to other fixed-income instruments.
Investing in gold has transformed itself over the centuries – from physical form to new forms like gold mutual funds and ETFs.
Gold shares an inverse relation with other asset classes. When other asset classes face a downturn gold value starts increasing. Hence, gold is an effective hedge against volatility and inflation. Yet returns from gold do not help in building wealth over the long-term
4) Real Estate
Out of all the asset classes, real estate is the most illiquid. Hence, investment in real estate should be on a need basis.
One should always refrain from investing in real estate. As there are chances that your investment would remain stuck in it for a long time. And, your funds will not be available to you when they are needed the most.
Within real estate, one can divide funds across different geographies, or different property types like residential or commercial. Real Estate investment trusts (REITs), and infrastructure investment trusts (InvITs) are new instruments that are gaining ground amongst real-estate investors.
5) Mutual Funds
Mutual Funds allow investors to put their money into a fund. The fund is then handled by the professional fund manager. Mutual Funds are one of the easiest routes to invest in equities for investors.
As per the risk appetite, investors can opt for equity funds or debt funds. They can have the best of both worlds by opting for Hybrid funds. Besides, investors can also invest in sectoral funds, multi-cap funds, or commodity funds.
Besides the traditional form of mutual funds, Equity traded funds (ETFs) and index funds are also up-and-coming asset classes that one can invest in.
While easy, mutual funds also have certain disadvantages. That may include a lack of control on actual holdings, commissions, high exit loads, and high expense ratios. Investors need to be mindful of the costs associated with a mutual fund before investing.
6) Bitcoin, Ethereum, and Other Cryptocurrency
Cryptocurrencies are another up-and-coming asset class that investors can consider. There are many exchanges and platforms available to invest in crypto.
Yet, the asset class is risky and marred by regulatory uncertainty. Besides, it is complex for most people.
Investors can consider this volatile and rewarding asset class at their own peril. One should only invest an amount one is willing to lose.
Advantages of Portfolio Diversification
A well-diversified portfolio is the one where risk is well-spread out across the different asset classes. Hence, it is in a better position to absorb the volatility during a market downturn.
It offers peace of mind as risk is reduced in comparison to a concentrated portfolio. Investing in different asset classes gives investors growth opportunities in different sectors.
Disadvantages of Portfolio Diversification
First, an investor needs to understand, that good investment opportunities are few and far between. And, the more you diversify, the chances of you making mistakes are higher. While trying to diversify, there is a risk of picking the wrong investments. As a result, the quality of your portfolio will go down which in turn, will dilute the returns.
Different asset classes have different structures and different working mechanisms. With over-diversification, there are high chances that you end up investing in an asset without understanding it. It can lead to unnecessary complications and possible losses.
Over diversification also increases tax compliance as tax structure differs across asset classes. Tax planning is an intricate subject and few investors are aware of it. Hence, investors may end up dealing with additional tax compliances or higher costs in the form of consultation charges of a tax planner.
It is best to focus on a few asset classes and not over-diversify one’s investments. Investors should also note that past performance does not equal future outperformance. So it is best to stick to assets someone understands. Or you can also invest with a trusted advisor.
Teji Mandi offers a diversified portfolio of 15 stocks. This portfolio is enough for someone interested in investing in the stock market. It offers a taste of both tactical and long-term stock investing for investors.