What is Diversification?

Diversification is a capital growth strategy which helps to minimise the risk by allocating the investment on different assets in the market. It is a strategy to enter into a new products or product lines, new services or new markets, involving substantially different skills, technology and knowledge.The goal of diversification is not necessarily to boost performance it won’t ensure gains or guarantee against losses. However it have the potential to improve returns for whatever level of risk you choose to target.

What is Diverse Investment Portfolio?

A Diversified Investment Portfolio helps to earn the highest return for the least risk. In a diversified portfolio, the assets don’t correlate with each other. It lowers overall risk because no matter what the economy does all the assets will not be in loss, profits margin will come out from other assets. Risk is also reduced because it’s rare scenario that the entire portfolio would be wiped out by any single event. So even if the market takes a complete U turn, the chances of losing the entire portfolio is minimal. This kind of  portfolio is one of the best defence against any financial crisis.

What is the need of Diverse Investment Portfolio?

We all do investment to earn from there. No one wants to invest a huge amount of money and in return to incur a loss. So the main need for diversification is for the safety of the investment by reducing the chances of entirely being in loss and to cope up with the ups and downs in the market.

How to Diversify a Portfolio?

Portfolio diversification is the crucial part of investment for better risk management. There are many benefits of diversification. Some of them are mentioned below, however the actions and decisions should be taken cautiously-

  1. Spread the Investment Area –
    Many of us have a tendency to stick to a single plan and if its giving high returns we don’t ever think to swap or to look in other investment areas or asset classes. Majority of time we ignore the risk factor of this and it may happen we might lose the entire investment. Like investing on equity is good, but you shouldn’t put all the wealth on a single stock as it increases the chance of loss also. So to get rid of this, we must follow a simple strategy which is to spread the money in different asset classes like pharmaceuticals, Information Technology (IT), consumer goods, mining, aeronautics, energy and so on. It depends on your comfort with different risk levels and goals.
  2. Analysing the Market –
    You should also keep an update with the daily marketing conditions and the current trend to get an idea whether its going to be beneficial or its in a downward trend. Also if the asset class is not preforming well or haven’t gave good returns in the past then its advisable not to go ahead with the particular investment or asset class.
    But taking a exit decisions based on short time market volatile for a big investment is not advisable as it may turn catch up the market soon.
  3. Plan your Diversification based on Market Cap –
    Its advisable to do a survey and find out which is the strong businesses and invest in those regardless of what the total market cap is. Large-cap & small-cap tends to rise and fall almost together. Mid-cap stocks typically are less risky, less volatile and may have less growth potential than small-caps—but they are more risky, more volatile and have higher potential gains than largecap stocks. So if you have to plan accordingly based on needs and choice.
  4. Try out for Index or Bond Funds –
    A sound diversification strategy is adding Index or Bond funds to the mix provides your portfolio with the much-needed stability. Also, investing in Index funds is highly cost-effective as the charges are quite low compared to actively managed funds. At the same time, investing in bond funds hedges your portfolio from market volatility and uncertainty and prevents from being wiped out entirely during market volatility.
  5. Mixture of Domestic & International Stocks-
    You should always try to maintain both the Domestic stocks and the International stocks. A good mix of International stocks is recommended to protect your portfolio against the local stock or market “shocks.” According to the financial expert one should invest 15% to 25% of the total invested money in the foreign stocks.

Conclusion

Diversification doesn’t guarantee that you will not face any losses. After the entire process, it is still possible to lose some money when you invest. It is not possible to eliminate risk completely. However, it helps you to lower the risk of losses in the market to the minimum possible. So its advisable to find a proper balance between the risk and the returns. And to stay updated about the market conditions which will help to take quick and necessary actions without being worried constantly about the portfolio.