How to Diversify your Investment Portfolio?
When it comes to investment, most people prefer to invest their hard-earned money in Bank FDs, Savings account or in Post Office Schemes. But according to most of the research and financial analysts investing all your money in one asset class is not a good theory. Instead of investing all your money in one asset class, it is better to diversify your portfolio and invest a portion of your money in all asset classes accordingly.
When it comes to investment, most people prefer to invest their hard-earned money in Bank FDs, Savings account or in Post Office Schemes. But according to most of the research and financial analysts investing all your money in one asset class is not a good theory. Instead of investing all your money in one asset class, it is better to diversify your portfolio and invest a portion of your money in all asset classes accordingly.
Diversification is the most basic and effective risk management technique of investment which one should know before making an investment portfolio. Let us understand the technique of- How much money one should invest so that risk can be lowered, and returns can be high.
There is always a mantra before investing that not to put all your eggs in one basket, which means do not invest all your money in one asset class. Else, it may damage your financial stability. There are different asset classes like Equity, Equity Mutual Funds, Debt Funds, Fixed Deposit, Gold, Real Estate etc. where one can invest their money according to their financial goals.
These days, markets are volatile because of corona and many other global factors. In the current scenario, traders should worry but not the investors. Interest rate reduction has come down, but the cost of borrowing has not come down to that level.
We believe going forward there will be policy rate cuts and RBI will transfer this borrowing cost to the consumers and there will be earning recovery in corporate sector by virtue of interest rate reduction and increase demand in the market.
Invest in Equity and Debt mutual funds
The thumb rule for any investment in a layman language is to invest at least in 20-30 stocks or invest your money through SIP in mutual funds. No doubt, equities, investment in stocks of different companies or through mutual funds are the ones which give good returns if invested for long term. Always try to invest in good fundamental companies with less or no debt. Apart from equity one can invest in debt funds.
For creating long term wealth investment in equity and debt funds can be a better option. In Debt mutual funds returns are a bit predictable, so one can invest accordingly. Lovaii Navlakhi, Founder & CEO of International Money Matters says- “The objectives of investment for any individual are to generate returns, ensure safety of capital and liquidity. These three objectives are not possible to achieve through one instrument and hence one needs to allocate funds separately for each of these purposes.”
Adhil Shetty, CEO, Bankbazaar.com says- "The interest is taxable for most debt instruments, so the post-tax return will be very low and won’t beat consumer inflation. Hence, it is essential for investors to have some growth-oriented assets such as equities to increase returns. That said, an investment cannot be 100% equity either and should contain debt investments even if your goals are all long-term. "
Right Allocation of Asset Classes
Too little risks can reduce the chances of attaining your financial goals. While, too much risk can lead you to face uncertainties in the market. Right allocation of assets can give you right amount of return focused accordingly for short-term, medium-term and long-term financial goals. There are four things you should consider while determining the asset allocation of your portfolio: your age, your risk appetite, your financial goals, and the time you have to meet those goals. You need to split your portfolio between equity, debt, and other investments taking all these four factors into account.
We know that to generate steady, sustainable returns, the tenure for investment has to be long term.
“To reduce risks of investing, the entry can be staggered or averaged, and finally there is a tactical call on whether to be overweight on large caps or midcaps or small caps. For safety of capital, one needs to generate returns post tax which beat inflation. Here again, quality of the (debt) investment, the duration over which one can invest, the lock-in for the instrument, etc. For liquidity, the focus is on just that – ability to access funds when required, and hence returns are not a prerogative.” opines Navlakhi
This is the reason right asset allocation is needed which is possible only with the help of diversification of investment in Equity, Debt, Gold, Real Estate etc. Never invest in only one asset classes without considering the risk and returns. Different asset classes perform or underperform according to the market conditions.
“One of the ways to manage risks is to diversify investments. So, we are not depending on any one single asset class/ product. It doesn’t matter how good the product is, if you have 100% of your assets in that, you are prone to risk - risk of non-repayment, reduction of interest, anything. In fact, too much of a good thing can be a bad thing too” is what opines Shweta Jain, Founder of Investography.
"Your asset allocation also needs to be dynamic. For instance, you may have a 100% equity allocation for a goal that is 15 years away, but as you come nearer to you goal, you should start shifting from equity to debt in a phased manner, keeping in mind the market situation as well." also adds Shetty
Rebalance or rebuild your portfolio
Portfolio rebalancing or rebuilding is one of the most important part of diversifying the portfolio. It balances the risk and returns of your investment. So, inorder to balance the need of your financial goals one should balance the investment. According to your risk and ability to invest rebuild your portfolio time to time to make your portfolio strong. There should be 60:20:10 ratio portfolio. Which means one should invest according to their age and risk 60 percent in equities or funds, 20 percent money in asset classes like real estate or Debt and not more than 10 percent investment in Gold.
Shetty says- "The purpose of balanced portfolio is not to get the highest returns, but to reach the goal comfortably. This is possible only when there is a good mix of equity and debt investments. The basic objective of diversification is to reduce risk. However, you cannot build a corpus by investing only in ultra-safe government schemes such as PPF, NSCs, FDs, and RBI bonds as these alone would not help meet future needs. "
Escort Securities, Research Head-Aasif Iqbal says- “Diversification is important to reduce the risk related to that particular asset class...So, one should allocate investment accordingly. There are some asset classes that provide stability but is low return because of low risk. Also, there are high return and high-risk asset classes. Allocation needs to be diversified amid asset class depending on the risk-taking ability. This is very important to note that even in one particular asset class one need to diversify the portfolio.”
Diversification
Before making an investment, an investor should learn the techniques of diversification. Without proper diversification of your goals, investments, selection of right asset classes or sectors nothing can be achieved.
Shweta says- “We also cannot predict what will do well in the future/ what the future holds and hence diversifying ensures that we are not at any one product/ asset's mercy. We have ourselves covered and protected.”
Some data on performance of various asset classes in the last few years show us that there is no single asset class which is always positive and in fact they could have inverse relationship which will help us manage our portfolios and risks.
Iqbal says- “Generally, there are four asset classes which investors mainly look for before investing- Equity, Debt, Real Estate and Gold. Real Estate gives 4-5% annualised return and 2% rental income. Equity gives return of over 15-20% depending on the risk. Whereas, Debt is stable, so, it is suggested to invest in Govt. Bonds or AAA rated bonds”. Metals like Gold, Silver is good hedge against inflation. According to the need or financial goal one should diversify his or her portfolio, so that they can achieve good returns without any risk or with low risk.
Relook/Review your portfolio
This is very important part while investing. Always relook or review your investment portfolio yearly or time to time according to your need. If you find any of the asset class or particular stock or fund not giving good returns to you in regular interval of time, then sell that asset class and invest in good asset class after checking all fundamentals, risk and returns.
Conclusion
This is very crucial to understand that no one can predict the financial markets. So, if you put all your money in one asset class like equity and suddenly market crashes the way it happened in the year 2008 then you will lose all your hard-earned money in one single way. This applies for all asset classes like real estate, gold, currencies, commodity, or any other investment. So, according to your objective of investment select the asset class. Do see risk management and returns. Check companies or sectoral situation according to the market situation. For long term investment risks is high but invest in blue-chip companies to get good returns.
Bottom line is- list down your financial goals, talk to your financial advisor, assess your investment risk and investment time horizon, invest in a suitable mix of asset class, and build a strong investment portfolio to get good returns. Don’t just over diversify your portfolio. Understand your objective of investment along with risk taking capacity and then invest.