A lot of investors make a common mistake by putting all of their money in one sector or a certain category of funds. The problem happens when it crashes, and they have to face a huge dip in their returns.
The truth is, even great stocks will not protect you from market volatility if you do not diversify your portfolio. Read this blog to understand why portfolio diversification is important for Indian investors.
What is Portfolio Diversification?
The process of distributing investments among a wide range of securities and assets with varying risk is known as portfolio diversification. This method entails that you may lower the risk of being overexposed to any one investment by spreading your assets. You can diversify your funds in different asset classes, industries, or even stocks from different countries.
The primary objective of portfolio diversification is to minimise and diversify the risk from your investment. During market fluctuations, positive performance in certain assets might offset negative performance in others.
How to Diversify Your Portfolio?
Consider the key principles to diversify your portfolio:
Asset Allocation
You can diversify your portfolio by distributing wealth across different asset types. A balanced portfolio typically consists of 40–60% equities, 30–50% bonds, and the remaining portion of other assets like Alternative Investment Funds in India.
Variety of Asset Classes
You can decrease correlated risks by investing in a variety of asset classes. To balance risk and return tradeoffs, you must take other assets such as currencies, commodities, precious metals, private equity, and alternatives into account.
Time Diversification
Rather than trying to predict short-term market movements, you must invest for long-term goals. The time diversification reduces performance vulnerability brought on by volatility and enables compounding to operate in your benefit.
Different Stocks
When it comes to equities, you must spread your investments across companies with different market capitalisations, industries, and sectors rather than focusing too much on any one business.
Geographic Exposure
Investing in stocks across different countries aids in mitigating the risks associated with individual countries. You will get mixed returns on investing in stocks from a developed nation and a developing nation.
Benefits of Portfolio Diversification for Indian Investors
Risk Mitigation
Instead of being too exposed to a single asset, diversification enables you to distribute and reduce risk. Economic or market factors that impact one asset class could not have the same effect on another.
Performance Improvement
Diversification allows you to reduce the volatility in your returns and increase your risk-adjusted returns. By diversifying your risk, you can enjoy the compounding benefit.
Minimises Volatility
Over time, portfolio performance is balanced by adding assets that are low or negatively linked. Positive gains from other investments balance out losses when some underperform. You can get this benefit by opting for PMS services.
Adaptation to Market Changes
Portfolio diversification also allows you to adjust to evolving economic cycles. Diverse assets may respond differently to geopolitical events, inflation, and other market factors.
3 Common Mistakes to Avoid While Diversifying a Portfolio
While diversifying your portfolio, you must avoid these common mistakes:
- Due to high expenses and smaller position sizes, portfolios that are too diversified typically provide unsatisfactory returns.
- The risk profile gets skewed when the initial asset allocation fluctuates with market fluctuations.
- Avoid panic purchasing during market peaks or panic selling after drops.
Final Thought
Portfolio diversification across different asset classes, sectors, and countries can yield better returns. It can mitigate your risks, improve your overall performance, and minimise volatility. However, you should not diversify too much and always choose the combination that best suits your financial goals and risk tolerance.
Comments