Diversification is a process through which investors can successfully optimize their portfolio. You might have heard the famous term “ Don’t put all your eggs in one basket”. But the question arises: how do you choose a different investment basket.
Many investors randomly choose baskets according to their choices and preferences, which is certainly not recommended by experts. Here, the fund manager plays a crucial role as they do a lot of research and select uncorrelated assets which help investors to minimize the risk and diversify the portfolio to an upper level.
Asset correlation is defined as how the assets perform with each other and when they belong to the same class, they are highly correlated. When one asset moves in an upward direction and other moves in a downward direction, they are negatively correlated. Therefore, if two assets are uncorrelated, the price movement of an asset may not impact on others.
For smart investor, investing in stocks, bonds and commodities help them to minimize the overall volatility of an investment portfolio. Smart diversification grabs the loss of one asset by balancing it with gains of the others. Smart diversification manages the loss and gain of all the assets.
There are different techniques through investors need to diversify their portfolio:
Alternative Investments
Alternative investments can be used to diversify the portfolio because the instruments do not have a broader correlation with the other asset classes including equity, bonds and more. Earlier investors used to invest in conventional channels such as real estate, commodities, but now they have started to move in more advanced asset classes such as private equity, high yield debt, venture capital.
Market Linked
Despite providing short term volatility, market-linked instruments provide huge returns in the long run. Direct equity and mutual funds are linked to the equity and debt market. The objective of the market-linked investment is to improve the value of asset and hedging against inflation.
When it comes to investment internationally, Indian trading can easily invest in international stocks in the portfolio. The Liberalized Remittance Scheme allows Indian residents to remit and invests up to $250,000 in a financial year.
The US has over 3500 publicly traded companies consisting of 5000 Indian listed stocks, expanding the diversification options. It is said that US stocks have been consistently outperformed the Indian stock market in the last decade. Another advantage of investing in US stock is that it protects your portfolio from the depreciation of Indian currency.
Safety
Safety is the primary concern of any investment. Generally, Gold and Fixed Deposits are looked as a safe investments. However, the main objective is to preserve the capital. Investors are preferred to invest in two categories.
- First-time investors who are learning the basics.
- Risk-taking investors are seeking fixed and regular returns.
Fixed Deposits have been the best investment channel for increasing wealth for a wide range of investors. Many Indians prefer 30% of their financial assets in fixed deposits and savings accounts. Also, investors invest in investment-grade debentures and bonds for better yields.
Gold is considered as the safest investment option in India. Also, it is widely used as a medium of exchange with low volatility and huge liquidity. Financial advisors also suggest adding gold in your portfolio for diversification and hedging. During the time of COVID 19, Gold has acted as the best hedging instrument against inflation. Also, Gold is negatively correlated to the equity market.
Retirement Planning
Many Indian investors have been deprived of enjoying security benefits post-retirement, especially in the private sector. This has completely changed the thought process of Indian investors to save up for retirement.
The popular modes of retirement planning are PPF and pension schemes. With the minimizing interest rates in the country, PFs are gaining a lot of popularity these days. Not only do they offer tax-exempt returns in the debt but also help in retirement planning.
Tax Planning
Tax savings help investors to increase the surplus income in one’s hand and hence improve the ability to invest. Insurance, equity-linked savings schemes, provident funds, and popular investment channels for tax savings. The primary objective of tax planning is to create a diversified portfolio while being tax efficient.
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