Diversify investment portfolio: a beginner's guide
Diversification is an investment strategy that involves manage one’s capital across a variety of assets or investment types to reduce overall risk. The goal is to build a well-balanced portfolio that can contain a variety of industries and asset classes in order to reduce the risk. In this article we will cover how to diversify investment portfolio.
It is the famous proverb of ‘not keeping all the eggs in the same basket’
For example, if you invest all your money in one company and company goes bankrupt, then you can lose all your money. If you divide your investment between two companies, you can lower your chances of losing money by, say, 50%. Different types of assets have different risk and return characteristics. Through diversification you will be able to balance risk and return to achieve desired result for your financial goals.
Your entire portfolio will underperform if you have a large investment in metal stocks and the global metal cycle declines. You can reduce risk by combining various assets that are not highly connected.
Starting early allows you to plan for your future and learn the importance of disciplined saving. You can start with a mix of cash, stocks, bonds, or government securities.
Table of Contents
Type of risk in Investment
There are two types of risk in equity investments Systematic risk or Market risk and Unsystematic risk. Market risk is cause by event which affect the whole economy of the country or world. When investing in stock, investors should be aware of the unpredictable nature of market risk.
The risk of share price of company falling due to poor financial performance or any unfavourable development which can affect the industry sector is known as unsystematic risk. Unsystematic risk can be diversified by investing in a portfolio of stocks.
Diversify equity portfolio on sectors and themes?
Let’s start by examining sectors. Industrial categories such as capital goods, consumer goods, medicines, information technology, etc. are referred to as sectors. For instance, steel and cement profit from increased building activity. When interest rates decline in the economy, banks and NBFC equities increase. When the commodity cycle moves upward, steel and oil profit. your equity portfolio must be diversified across such sectors.
Diversify by Theme
A variety of industries are covered under themes. For example, rate sensitive is a theme. Banking, NBFCs, automobiles and real estate benefit when the interest rate are headed down. If you are diversifying by theme ensure that you are not overexposed to one particular theme. Similarly, tractors, two-wheelers, FMCG goods, agrochemicals, fertilizers, and hybrid seeds are all benefited by increased rural incomes. This is known as rural demand. A careful selection of themes is another aspect of diversification.
How to diversify investment portfolio across different asset classes?
In general, stocks and bonds are the two main categories of investments. Bonds are typically more stable with lesser returns, whereas equities are thought to be high-risk and high-return investments. You should allocate your funds between these two possibilities to reduce your exposure to risk.
Actually, this is the first step in diversification, at this stage you just combine equities, debt, hybrid asset classes, ETFs, index funds, gold, property, foreign assets etc.
Debt Investment: The Indian government and private corporations occasionally issue bonds that provide a set amount of “fixed” returns over a predetermined period of time. Putting money into these debt instruments could provide you with a set, risk-free return on your investment. Fixed Deposits, Bonds/Debentures, National Savings Certificates, Kisan Vikas Patra, Treasury Bills, etc. are a few instances of debt instruments.
Equity Investment: Highly volatile, highly risky. However, if executed carefully, the benefits are enormous. The two main methods for investing in the equity market are direct stock purchases and mutual funds.
It is recommended that non-professionals invest in index mutual funds, as they are likely the safest type of stock investment
One may also seek advice from an investment professional before investing in mutual funds.
Investment in Gold: One of the popular investments of Indians. For long-term investments, is Gold. It is safe because it is thought to be less volatile and extremely safe.
Gold might serve as a safety net for finances in an emergency. Today there are multiple ways through which one could invest in gold. You can buy gold jewellery and/or buy pure grade gold in the form of coins, biscuits, bars, etc.
Understand the factors that affect the financial markets.
You need to understand the factors that affect the movement of the financial markets before making any investments. Stock exchanges, foreign exchanges, bond markets, money markets, and interbank markets are examples of financial markets. In basic terms, these are financial instrument markets, and just like any other market, their operation is based on supply and demand.
The other major influence is the central bank, the Reserve Bank of India, and its monetary policies.
Final Word
The road to a well-diversified portfolio may have its twists and turns, but with patience, diligence, and a diversified mindset, you’ll be better positioned to navigate the complexities of the financial markets and work towards a more secure financial future. Happy investing!