Tips To Diversify Your Investment Portfolio

Having a diversified investment portfolio is not having all the eggs in one basket. It is about investing your investible surplus across a set of asset classes. Diversification does not necessarily eliminate risks. It lessens the risks your investments face. Different asset classes can react differently to an economic event.

Investors tend to react or think of diversification during two extreme events: 1. When the market has sharply risen; and 2. When the market is sharply down. By the time an investor reacts, most of the damage to the portfolio is already done. That’s an unhealthy way of reviewing your investments. Every investor should have the habit of reviewing his/her investment portfolio regularly.

Diversification tips investors should follow:

  • Own a variety. Invest in a variety of asset classes – equities, government bonds, corporate bonds, fixed deposits with banks, etc. Such a diversification saves you from all your investments going bad at the same time, except when major events such as the 2008 global financial meltdown strike. 
  • Diversify within each class. Have exposure to diversified assets within each asset class. Within equities, spread your investment in shares of various sectors. Similarly, investments in corporate bonds should also be diversified into various sectors. Exposure to just a couple of companies or to just one or two sectors has the potential of far greater harm to your investment portfolio than spreading investments to many companies and sectors.
  • Invest in companies of all sizes. Investments should not be concentrated in same-sized companies. You might invest in companies from different sectors but all belonging to small-cap segment. This too is not diversification within equities. A market development can pull down or pull up shares belonging to small-cap or mid-cap or large-cap segments all at once. Spread your investments in small-cap, mid-cap, as well as large-cap companies.
  • Mutual funds. Having direct investments in equities is not bad if you understand investing. If you are not adept at understanding investing, mutual funds are your best investment vehicles. Mutual funds have fund managers and research teams. Investing in mutual funds gives access to this expertise.
  • Diversify even within mutual funds. An investor might invest in schemes of several mutual funds but all of them with similar investment objectives. This does not result in diversification. Choose schemes with different investment objectives, whether they belong to the same fund house or more than one.

An ideally diversified portfolio cannot be built in one shot, unless you have won a lottery or hit a jackpot. A portfolio to meet your future financial needs is built over time. A diversified portfolio is similarly built over time.

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