Ramalingam K, Certified Financial Planner and Investment AdvisorDirector, Holistic Investment PlannersChennai
?? Don’t put all your eggs in one basket ?? is a phrase that we picked up in school as we became familiar with the intricacies of the English language. However, some of us learned the hard way when we accidentally dropped a basket full of eggs. The result is a mess, monetarily, physically, and visually, after all.
So what’s the cure? Obviously, it’s easy to split the eggs and keep them in separate baskets. In the financial world, many investors are taking the opposite path. They disregard this tried and true idiom. Their fate is the same as that of broken eggs.
How do you diversify your investments?
Even at the cost of repetition, it must be reiterated that if a portfolio is not diversified, the investor runs the risk of being financially wiped out. It is always useful to remember that if the base of a physical structure, be it a building or a monument, is wide, it is literally on better ground. The investor is better off because of the diversification or spread of the investment corpus.
The process of portfolio diversification is neither easy nor unique for investors. When trading on the stock exchange, investors must be taught a disciplined approach. To assign
Investing in different financial instruments is the key to diversification. While no market expert will ever argue that diversification can protect against market losses, it is certain that it will help mitigate damage when things are bad.
Consider an example where a wealthy individual has assets worth 5 crore rupees. Of this, the value of his immovable property in the form of a prime location in Mumbai is 4.5 billion rupees. If his home is suddenly and irrevocably damaged by an unforeseen act of God, then all of his investment value will be wiped out.
Another example is about this gentleman who liked to buy shares in a certain IT company. Those stocks had given him lavish returns over the years, so he never thought about it. One day the market turned upside down and all his money went for a toss.
These are examples that we come across frequently that adequately highlight the negative effects of nondiversification. Here are six very useful options for readers and investors to follow for portfolio diversification:
I. Across all asset classes: Not all investors are familiar with the nuances of the stock markets and it is always safe to invest in a number of avenues such as stocks (stocks, mutual funds), debt, commodities like gold and / or silver, etc. Real estate and hold some cash.
II. Within the asset class: A particular asset class consists of similar types of options for different companies or instruments. The investments can be spread across different sectors. FDs can be made with different banks. Instead of investing in an equity fund, you can split it up into 3 different equity funds.
III. Across geographical boundaries: Investors can distribute their investments globally at any time. This will add dimension to the investment corpus as it has the added benefit of benefits arising from currency fluctuations. Real estate can be purchased in different countries around the world. This gives the investor a fair chance to minimize losses in the event a country is hit by natural disasters or political upheaval. This protects you from currency fluctuations.
IV. Across Capitalization: If you invest in the stock market, you can spread your investments over different market capitalizations such as small cap, mid cap and large cap. You can make this diversification both with direct investments and investments through mutual funds. Large caps are less volatile compared to mid and small caps. Compared to large caps, mid and small caps have a higher return potential.
V. Across Time: Investors can systematically distribute their investments using the time index. Some short term (say 3 years), some medium term (3 to 5 years) and other long term (over 5 years) investments will give the portfolio good balance and flair. A little planning will help the investor determine their life and investment priorities accordingly. From buying a house to studying children and getting married, everything can be achieved through time-bound investment decisions.
WE. Across all styles: Style means that the investor can choose between regular income generation and capital growth. You can also spread your stock investments across different investment styles such as value investing and growth investing. You can diversify your debt portfolio with investment styles such as period-based fund management and duration-based fund management.
It is relevant to note that overdiversification can turn out to be counterproductive, after all, “too much of everything is bad”. and, following Warren Buffet’s dictum, “Broad diversification is only necessary if investors don’t understand what they are doing,” it is better not to overdo things. A sensible approach in which the investor stands still, a balanced and not too broad portfolio is considered ideal.