Portfolio diversification: Reap Returns with These Strategies
Created on 20 Apr 2020
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Updated on 31 Aug 2020
Diversify Your Risks: Reap Returns with These Strategies
Investing should be treated as an art and one should learn and adopt the nuances of investing from a young age. It cannot be a knee-jerk reaction, hence one should inculcate a disciplined and not a reckless way of investing with a diversified portfolio. A well-diversified portfolio along with a predefined investment horizon can weather most storms.
A diversified portfolio is a portfolio constituting investment products of different risk levels and yields, which would lower the assumed risk and leverage a significant percentage on the variance of the portfolio performance. Rational investors select a proper allocation of assets to match their investment profile - aggressive or conservative and maximize the return on their portfolio. Aggressive investors usually assume a higher level of risk, expecting higher returns, while conservative investors seek to preserve their earnings and maintain the value of their portfolio. Nevertheless, investing in different classes of assets allows investors to venture into international markets or different sectors and potentially lower their portfolio risk.
A typical diversified portfolio has a mixture of stocks, fixed income, and commodities as these assets react differently to the same economic event. It lowers the overall risk exposure as no matter what the economy does, some asset classes will benefit that would offset the losses in the other assets. Your risk exposure is also reduced since it's rare that the entire portfolio would be wiped out by any single event. This is your best defense in the eventuality of a financial crisis.
One of the keys to a successful investment portfolio is learning how to balance your comfort level with risk against your time horizon. Yes age does play a contributing factor in your investment route. Investing in your retirement nest egg very conservatively at a young age, and you can run the risk that the growth rate of your investments will not keep pace with inflation. On the other hand, if you invest too aggressively when you're older, you could leave your savings exposed to greater market volatility, which could erode the value of your assets at an age when you have limited opportunities to recoup your losses.
How much should one invest in each asset class? There is no one-size-fits-all best-diversified investment. Investors use asset allocation to determine the exact mix of stocks, bonds, gold, real estate and money market instruments. It depends on your comfort with different risk levels, your goals, and where you are in life. If you need the money in the next few years, you should hold more bonds than someone who could wait 10 years. So, the percentage of each type of asset class depends on your personal goals. This can be discussed with your financial planner.
Here are five tips for helping you with diversification:
Spread the Wealth
Equities can be a good option for investment, but don't put all of your money in one stock or one sector. To diversify your investment portfolio in shares one should not only look out for blue-chip companies but also market capitalization. So, take your pick from small-cap, mid-cap, and large-cap stocks for your basket ranging from different sectors. Nowadays one has the option to invest in foreign stocks. For this you could include companies from both developed and emerging markets. International investments can generate a higher return as emerging markets countries are growing faster. But they are riskier investments because these countries have fewer central bank safeguards in place, are susceptible to political changes, and are less transparent.
Consider Index or Bond Funds
Index funds or fixed-income funds can be considered as another option. Investing in securities that track various indexes is a sensible long-term diversification investment to your portfolio. By adding some fixed-income solutions, you are further hedging your portfolio against market volatility and uncertainty. Index funds are eye-catching to the investor as they invest in a broader market index – like the Sensex or the Nifty. It ensures a performance identical to that of the index, that is being tracked. Low expense ratio is its main USP as it is not actively managed funds, thus incurring low expenses. They do not aim at outperforming the market, but instead to maintain uniformity.
Bonds are an ideal investment for average risk-averse investors who are looking for stable & regular income.
Favorite investments - Gold and Real Estate
Gold investment can be done in different forms like buying jewelry, bars or gold exchange-traded funds. Factors such as high liquidity and inflation-beating capacity, gold is one of the most preferred investments in India. Though there are times when markets see a fall in the prices of gold but usually it doesn’t last for long and always makes a strong upturn. Once you have made your mind to invest in gold, you should decide the way of investing meticulously.
Owning real estate is an investment strategy that is long term as well as lucrative. Prospective owners can use leverage to buy a property by taking a loan and then paying it off over some time. The rental income as well as the appreciation in the property value would give you a good return on the investment.
ULIPs Mutual Funds FDs
ULIPs and Mutual Funds are easily manageable for a novice investor. These options should also be explored. With the falling interest rates and banking fiascos FDs are losing their value when it comes to investing as the returns are low.
Don't spread your wings too far
Make sure you hold on to a portfolio that's manageable. There's no sense in investing in 100 different vehicles when you don't have the time or resources to keep up. Try to limit yourself to about 20 to 30 different investments
Keep Building Your Portfolio
Add to your investments regularly. This approach is used to help smooth out the peaks and valleys created by market volatility. This way you can cut down your investment risk by investing the same amount of money over some time.
Know When to Get Out
Stay abreast of the changes in overall market conditions. In doing so, you will realize when it's time to cut your losses, sell and move on to your next investment.
Factoring time into your strategy
People are accustomed to thinking about their savings in terms of their personal goals: retirement, college, a down payment, or a vacation. But as you build and manage your asset allocation—regardless of which goal you're pursuing—there are 2 important things to consider. One being the number of years until you expect to need the money that is your time horizon. The second factor is your attitude toward risk or risk tolerance.
The Bottom Line
You will receive the highest return for the lowest risk with a diversified portfolio. For the most diversification, include a mixture of stocks, fixed income, and commodities. You can consult a financial planner who will be able to assist you in determining your asset allocation based on your personal financial goals. This entire process can be educational, informative, and rewarding. By taking a disciplined approach and using diversification, averaging strategies, you may find investing rewarding even in the worst of times.
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