Many of you have heard the saying “ Don’t put all the eggs in one basket”.
This means if a farmer gets stumbled while carrying the egg basket, he could end up in a messy situation as all the eggs present inside the basket become messy which makes the whole basket dirty.
The meaning of the words perfectly said that don’t risk all of your money on a single investment.
Diversification protects your investment as it allows you to invest in multiple asset classes which in turn saves you from losses that could happen in one particular sector.
Let’s understand with an example: Everyone knows about the equity crash that happened in 2008-09.
As per the reports, during the 2008-09 period, equities crashed by 39%. Had you invested all the money into equities, you would have probably been into major losses.
In any case, if you had spread all of your investment into different asset classes, such as equity trading, debt, commodity trading etc, you would have been saved from huge losses.
In 2008-09, gold gave outstanding stock trading returns of 24%. The same went for debt. In the next two years, post-2008-09, the equities were seeing a rising mode as it would go up by 24% while other asset classes stopped giving good returns.
What is Portfolio Diversification
Portfolio diversification refers to investing your money across multiple asset classes which not only helps your money grow but helps you mitigate your losses to a greater extent.
In diversification, you owe different stocks from multiple industries, countries, commodities and other investments such as gold, silver, bonds, government instruments, and real estate.
Investing money in various sectors minimizes the permanent loss of capital and the volatility of the overall portfolio.
The Real Purpose of Diversification
The primary motive of diversification is to minimize risks. But no one can achieve that by investing in highly safe instruments such as government investment schemes like PPF, Treasury bills, RBI bonds, NSCs etc.
This is because investing all of your money into government schemes will significantly reduce your overall returns. For instance, investing all of your money in NSCs, and PPF debt options won’t help you get outstanding returns.
The portfolio should be filled with equity-related instruments, only then you would be able to achieve handsome returns in less time.
For those who believe in government investment schemes, you should remember that most of these schemes have a high tax. Hence, your post-tax return would come out as very low.
Many of you would love to gain good returns over less period of time, that too without taking a risk. This cannot happen in real life. To get ample results from your investments, you need to take a reasonable level of risk.
What Should Be An Ideal Portfolio?
An ideal portfolio should be one that has more than 5 asset classes.
Here are the tips for getting an ideal portfolio:
1) Include 10 + More Stocks Of Various Sectors into your Portfolio
Investing in multiple sectors is the best way to build your portfolio. Stocks of multiple carry their own weightage which will increase your portfolio’s value. Also, stocks of different sectors will minify your risks at a certain level.
Suppose, if the stocks of IT keep on falling and other sectors of stocks of crude oil and pharmaceutical companies grow, will eventually balance your portfolio in a much better way.
Don’t fill your stocks with one particular sector. It does look tempting to buy many stocks of the well-known giants, but it’s not a complete diversification.
For instance, if a sector gets affected by the economic slowdown, the company’s shares would fall.
2) Reserve a Portion of Portfolio into Fixed Income
Many investors suggest putting a small portion of fixed income assets in their portfolios. Fixed income instruments like government bonds, may give fewer returns compared to equities but they will also reduce a portfolio’s risk profile and volatility.
The stock market is full of volatility. In many cases, we have seen where the investors lose a great amount of money by investing heavily in equities. In such cases, people find fixed income instruments a great way of investment as they provide them with easy and secured returns.
ETFs are the best example of fixed income securities.
3) Invest in Real Estate
Investors who want to make a strong portfolio should invest in real estate. It is seen that putting money into real estate not only increases your return but also minimizes your portfolio’s volatility.
Factors That Impact the Portfolio:
Age is an important factor in asset allocation. Investment experts say that young investors need to invest a lot in the equity segment. Investors aged 25 to 35 should have equity allocations of 75% to 80% while people of age more than 35 years should have lower equity allocations.
Willingness to Take Risks
Investors, especially the young ones, should have a willingness to take a certain risk during their investment journey. This is the time when you can learn a lot of things even from your failures.
Many people are often afraid of the term failure, but the term itself teaches you many lessons in real life.
If you are a beginner but want to earn a lot of wealth from the stock market, there are many things you need to learn. Stock picking is not the easy thing as it seems to be. It requires a lot of stock market research, analysis and most importantly knowing the market volatility.
For generating better returns, you need to put money into the stock market, then only you will get to know how the stock market exactly functions well.
Focus on Long Term Investing
New investors need to understand long term investing. Beginners think that 6 months or 1 year is the best holding period, however, it is not correct. One year of equity holdings will not give you satisfactory returns as there are taxes included in it.
For generating better wealth, you need to hold your equities for at least 5 years.
Many investors think that the more they add stocks to their portfolio, the more will be their wealth. Hence, they keep adding more stocks to their portfolio. Modern portfolio theory says that investors should keep 10-15 stocks of one sector in their portfolio.
Portfolio diversification doesn’t mean that you will never incur any losses. The role of diversification is to mitigate risks against stock market volatility. Diversification can reduce the risk up to a certain level.
If you want to achieve huge stock trading returns, make the investment a long term journey. Maintain a good balance between risk and return, only then you will become an ace investor.