A diversified portfolio helps your overall investment to protect itself from any shocks or disruptions thereby providing you the best balance for your saving plan. Remember, diversification is not just limited to the type of investment or classes of securities; it also extends within each class of security. Thus, one must invest in different industries, interest plans and tenures. For instance, one must not put all their investments in a particular sector like pharmaceutical but must diversify by investing in several sectors like education, information technology, chemicals etc.
The core philosophy behind diversification is “Do not put all your eggs in one basket”. The rationale behind a diversified portfolio is to create a mix of assets that would yield higher risk-adjusted returns over the long term. Since we are talking about portfolio diversification, it is vital to consider the positive impact the global diversification can have on the stability of your portfolio. This happens because stocks in developed markets are more stable and there are broader investment opportunities available for investment in the global stock market.
Here’s how you can go about with diversification of your portfolio:-
- Diversify among asset classes
The first step to diversifying is that you diversify across various asset classes. Thus, you must combine equities, debt, hybrid asset classes, index funds, ETFs, gold, real estate, foreign assets etc. Diversifying in this manner ensures that your overall risk is spread across various asset classes and the overall portfolio risk is reduced.
- Diversify by companies
You also need to diversify based on various companies. For this, you need to combine companies with higher operating margins with companies that have high asset turnover ratios. Moreover, you must also study the financial ratios of various companies to determine which companies to invest in. For e.g. if you combine high growth stocks with high dividend yield stocks, the net outcome will be positive.
- Diversify within debt based on duration
Your portfolio should be the right balance between liquid funds and debt funds. Within debt funds too, you must decide the time duration during which you want to stay invested. This will depend on your outlook on interest rates.
- Diversify within debt based on quality
Once you have identified debt as an asset class, the next step is to diversify debt on the basis of asset quality. For this, you need to decide how much should be invested in risk-free government securities and how much in state government securities. You can also decide on how much amount you wish to invest in corporate debt. Ideally, you must invest in corporate debt with AAA rating or AA rating. Any debt below these ratings entails higher default risks.
- Diversify by Sector
One of the quickest ways to build a diversified portfolio is to select stocks from various sectors. You can set a thumb rule when you own stocks from several sectors like information technology, pharmaceutical, chemicals, manufacturing companies etc. While it may be tempting to purchase a number of stocks from the same sector, it is not advisable to do so. This is because if one sector underperforms, the other sectors take care of your portfolio.
- Diversify by Geographies
Geographical diversification is of utmost importance. It means that you must hold securities from different regions. You would not want all of your money in a single country or a region for the same reason you do not want it in the same sector. When you invest in various countries and regions, you are not dependent on the stock market performance and economy of one country. It also helps you leverage the benefits of performance of other economies.
Diversification is a pillar of investing and one must not create a portfolio that is not well-diversified as it can lead to wrong consequences. Proper asset allocation across a mix of global assets can help your portfolio become better and deal smartly with volatility in future.
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