Portfolio Diversification Will Optimize Your Investment Returns
Jan 07, 2019 | 14:59 PM IST
Jan 07, 2019 | 14:59 PM IST
If you want to build a robust stock investment portfolio for your future. Then you must understand the concept of portfolio diversification. Portfolio diversification is the key aspect of portfolio management. And with proper portfolio diversification, you can optimize and safeguard your returns.
We have all heard the phrase - don't put all your eggs in the same basket. This is most applicable to your investment. Portfolio diversification suggests you the same in the case of stock market investments. If done right, your stock market investment could rain money for you. So, being an investor let's understand the concept of portfolio diversification, its benefits and Do's and Dont's.
1. Benefits Of Portfolio Diversification
A. Portfolio Diversification Minimises Risks
In case one of your eggs goes bad or in terms of investing - doesn't perform well over a certain spell of time, your other eggs may hatch better. Doing so, you have assured at least one omelet or boiled egg. As similar to this example if one of your investment turns negative or performs poorly in the certain time span then other investment may help you to cap these losses or survive in such a situation.
B. Portfolio Diversification Helps You In Preserving Capital
Depending on which phase of life you are in, financially you would either be in accumulation or preservation of capital mode. Generally, HNI's and people close to their retirement are focused more on the preservation of their capital. By diversifying you can protect your savings.
C. Portfolio Diversification Helps In Generating Returns
Remember all those heist movies where even after meticulous and foolproof planning the thieves/heisters still get caught. Investments too can go the same way. No matter how well you've planned/invested, there's bound to be certain situations wherein your investment doesn't perform as you expected. By diversifying you aren't depended on a single source for income.
2. How To Build Diversified Portfolio
We understood the diversification as well as the importance of the diversification, but the question remains ahead is how one can build a diversified portfolio? Broadly there are five ways of doing it. Let's explore these five forms of diversification that you should understand and include in your stock portfolio.
A. Company-level Portfolio Diversification
Individual company diversification is nothing but constructing a sound mix of the various stocks of the individual companies. It can be done with the proper research of the various stock from the various sector. The goal behind this diversification is to own the securities or stocks of the various companies to get benefited and earn profits.
B. Industry-Level Portfolio Diversification
Just like implementing a mix of individual companies, the industry diversification is also an important way to diversify your portfolio. As not only having a balance across the multiple different companies but also among industries in the economy is important too. It's especially recommended to diversify away from the industries with which you are most familiar with.
For example, being a pharmacist or doctor one may have sound knowledge of the industry and its special features and potential but because of this overweighting pharma may cause a huge harm to the portfolio as any sudden happenings or any macro economical aspect like rupee depreciation occurs all the portfolio may turn red and play a spoilsport for your own hard earned money. The point is, just like with individual company stocks, it's not healthy to favour and put extra money in a single industry that you are aware of.
C. Portfolio Diversification By Asset Class
Asset class diversification is something you can't just consider in the case of a stock portfolio, it's more relevant to the investment portfolio as a whole. There are different asset classes other than stocks like bonds, real estate, commodities etc. These asset classes perform differently in different economic conditions. For instance, during an economic recession, the debt securities like bonds safeguards the returns however in the economic recovery phase the equity investments turn out to be the performing gems.
D. Strategic Portfolio Diversification
The strategic diversification is useful in getting weighted exposure in various stocks and securities. There are strategies like the smart beta which replicates the indices in a weighted manner as well as there are strategies which are usually preferred by investors like growth strategy, value strategy, momentum strategy etc. However for implementing these strategies, one needs to get a professional advice as these strategies are closely related to the risk appetite of the investor. For most, the best approach to get best returns is a blend of these strategies with the realization of risk associated with every strategy and return potential from the various stocks.
We at Niveza offer such a good blend of stocks by considering your risk appetite as well as your financial goals with our flagship product p3600 (Personalised Research Service). This is a very personalized service wherein we also allocate a free equity dealer for you to take all the potential opportunities at right time and assure you won't miss any one of them. Making your life free from market hassles we also assure that you would make money with our performance guarantee and at the same time offer you an added benefit of ZERO BROKERAGE.
E. Geographic Portfolio Diversification
Usually, investors prefer investing in stocks or securities in the domestic market. However, by following these investor face losses when the domestic markets fall with the macroeconomic concern. For example recently when INR that is Indian currency depreciated against the US Dollar then the US markets have performed a bit better than the Indian markets. If one has invested in the securities from the US market they may have managed to survive in bleeding markets.
3. Do's and Dont's of Portfolio Diversification
A. Always Keep An Eye on Current Asset Allocation
If you are an active investor then the first and most important aspect is to review the current asset allocation of your portfolio to understand where it stands currently and where you need to concentrate to optimize returns and diversification.
B. Always Consider Your Age
Your Age is one of the major influence rs for your portfolio. 100-minus age is one of the majorly used assets allocation strategy. Here your age is considered to analyze your risk appetite. The strategy defines that when you are at a younger stage of life you can take more risk, for example, the person with the age of 25 or 35 can allocate around 75 to 65% of assets in the equities.
C. Always Consider The Ability To Take Risk
The investor always needs to understand and consider the risk-taking capacity while investing in the equities. People with a steady income are able to take the higher risk as the market volatility won't impact their monthly inflows thereby lifestyle. But this is won't be possible with the investor who is retired or near to retirement. The basic need of such an investor is more likely to be the steady monthly inflows.
D. Don't Think In Short Term, Think Long-Term
This is the specific rule for novice investors, many of the investor fall in this trap. They consider holding period as one year or less than that, however, to create wealth one need to stay invested for the longer term. Even if you see the historical performance of many stocks the one who held it for more than 3 years have bagged manifold returns. So when you diversify your portfolio, you should be determined about the time horizon for which you will be holding these stocks and plan accordingly.
E. Don't Ignore The Other Asset Classes
Even though you are able to take a much higher risk and able to contain losses its quite risky to invest 100% of your corpus in equities. One needs to have emergency corpus as well which would be in hand and accessible. Therefore holding cash and other investments in asset classes like bank FDs, debt instruments, international equities etc could be beneficial to cap losses as well as it will play a role of plan B for you when you will face losses.
F. Don't Over Diversify
Many investors tend to assume that higher diversification leads to better returns. According to modern theory, it has been considered as 15-20 stocks from different sectors are well enough to construct a diversified investment portfolio. The key purpose of diversification is to reduce risk, even if we see the correlation of bigger portfolios of mutual funds or any other ready-made portfolio we can see that post certain limit return capabilities are deterred. So its wise to have a balanced portfolio it should not be concentrated or over-diversified in both the cases returns and risks are hampered.
From the above discussion, you may have understood the importance of portfolio diversification as well as the key things you need to follow. To diversify the portfolio and implement a perfect mix of stocks as per your risk appetite one need to have extensive stock research as well as market expertise. The aspect seems to be easy but when you do it on own it's an uphill task. If you are an investor who lacking financial acumen, or crazily busy in your day to day schedules then portfolio management service is a one-stop solution for you. If you want to explore the best PMS available in India then read Best Portfolio Management Services In India.
Niveza Editorial Desk :
We are a team of stock market nerds trying to stay ahead of the herd. We spend our grey cells everyday to a pave a smooth road for our clients in the shaky world of stock market. While tracking the mood swings of the market we bring our clients the most rewarding deals.
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