Why diversification is the foundation for Wealth Creation
The Thumb Rule of wealth creation says don’t put all your eggs in one basket. It restricts the damage to your financial well-being in case one asset class or instrument goes for a toss.
Why to diversify our Portfolio.
The basic objective of diversification is to reduce your risk by spreading to different Asset Classes. Diversification is a risk-management technique that mixes a wide variety of investments within a portfolio. Risk and Return are always goes hand in hand, though everyone would love to earn high returns without taking any risk, in real life one has to manage risk and return together. “What investors should aim is for decent returns with reasonable level of risk,” The best way to do this is by following a disciplined asset allocation strategy. Most investors tend to focus on keeping their savings in a particular investment or asset class.
Asset allocation
The simplest way to diversify is through asset allocation. This means spreading your investments across a range of asset classes such as stocks, debt, cash, mutual funds, bonds, real estate and gold in a systematic manner. That way, if equity markets give poor returns, you can offset it with gains from investing in fixed income and gold. The ideal asset allocation for an investor depends on the investor’s risk appetite. The higher the risk appetite of the investor the higher proportion of his investment should be in equities. In order to determine your risk appetite, you should consult an investment advisor who can guide you on the details.
It is also important to remember to diversify within asset classes as well. This is especially true regarding equity investments. It is important to remember that while buying equities is an important part of a diversified portfolio, holding similar stocks is a risky practice. IT stocks had given investors great returns during the period of 2013-2015 (an annualised return of 31%). However, the performance for the sector from 2015 onwards has been negative with an annualised return of around -3%. Investors who manage their own stock portfolios need to avoid concentrating into any one particular sector or stock to avoid such a situation.
Diversified equity portfolio
One way to have a diversified equity portfolio is to invest through equity mutual funds. Equity mutual funds are managed by investment experts who ensure that the holdings of the fund are diversified across different sectors. By buying an equity mutual fund, an investor gets the benefit of owning a diversified equity portfolio that is also actively managed by investments experts.
Diversification is a tool that helps all types of investors—from the small-time individuals to the largest institutional investors. Until a few years back, it was hard for individual investors to reliably measure whether their investments were appropriately diversified.
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Sathish Kumar
Wealth Consultant
Wealth Consultant | Equity Fund Manager | Author
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