Diversification, simply put, is creating an investment portfolio which has securities added from different asset classes or different securities within the same asset class with different risk and return profiles. Why do we need diversification? It is because the prices of different securities do not rise or fall in tandem, which means when one particular investment is suffering the others might do well. Hence, diversification protects your investment and makes its performance less volatile.
Most commonly used phrase to explain this is – ‘Don’t keep all your eggs in one basket’.
Consequences of losing the basket and hence losing all the eggs, are well known. Likewise, if you invest all your money in just one mutual fund, or one category of mutual fund or if you buy just one particular stock or a sector, in case this particular category underperforms, you risk losing a large percentage of your money.
Effect of not diversifying your portfolio:
Post COVID-19, while the broader markets nearly doubled from their Mar’20 lows, the auto sector continued to underperform due to the lack of semiconductor chips. If you were the person who has inverted all your wealth in auto stocks or theme based mutual funds which mostly invests in auto stocks, you will need to wait for a longer time for the segment to rally, or might end up losing your money if you sell at a loss.
How you should diversify your stocks:
This is easy, you should not invest all your money in the same kind of stocks. If you have invested your money in stocks of technology sector have some stocks in Financial sector or Manufacturing or Real Estate.
How you should diversify your mutual fund portfolio:
Do not always invest in just one category of mutual fund. Choose from different mutual fund types based on market cap of the company eg. Large Cap, Mid or Small Cap or Flexi-Cap, underlying asset class e.g. Debt, Equity or hybrid, or even domestic equity or international equity etc.
Disclaimer: The sector mentioned herein are for general assesment purpose only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. Past performance may or may not be sustained in future.
5 straight to the point reasons, why you should diversify:
First and foremost, as you would have guessed, Diversification of portfolio reduces your risk. Your portfolio performance becomes more consistent, less volatile.
Your portfolio diversification activity, if done well, brings you closer to your financial goals, due to lesser risk and consistency in returns.
With diversification, you can take advantage of different kinds of asset classes, e.g Gold ETFs, which you might not have experienced otherwise.
Apart from different asset classes, diversification allows investors to get familiarized with different investment strategies e.g. Value focused, Growth focused or Flexi cap funds to learn from how the fund manager balances the portfolio from time to time.
And finally, utilize the power of Mutual funds as one of the best ways to achieve diversification without need to have in-depth knowledge of each asset class.
So we learnt today that Diversification cancels out individual securities fluctuations, whether 1 particular stock, sector, mutual fund or mutual fund type, and brings a consistency in your portfolio performance.
We hope you have learnt something new today, as it is our constant endeavour to educate and make an ‘investor’ a ‘sound investor’! Happy Investing!
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