Investing in the stock market is nothing short of a roller-coaster ride. The investment strategy should be such that an investor is able to maximise profits while minimising losses.
In this regard, diversification is a strategy that spreads the possibility of losses across various investment tools and asset classes. This means that an investor can offset the losses from one investment instrument through the profits achieved from another investment loss, which ultimately results in an overall positive portfolio performance.
Diversification is the first step when it comes to adopting a healthy investment strategy that ensures higher profits and less risk. The process of diversification lies in its types, which include asset-class diversification, industry and sector-wise diversification, and geographic diversification.
Asset-class diversification: For any investor, it is comparatively easier to ensure diversification by allocating a portion of the capital amount to a different asset class. For instance, in case an investor’s target asset class is equity, they can invest a portion of the capital in a different asset class, such as bonds, real estate, commodities, or derivatives. Asset class diversification significantly reduces the negative effects of a bearish trend of an individual asset class.
Industry and sector-wise diversification: In an industry and sector-wise diversification, a retail investor spreads their investment in a specific asset class into securities belonging to multiple industries or sectors. For instance, let’s say an investor is investing Rs 1,00,000 in equities; he can spread this amount in stocks of multiple industries and sectors to cut the risk of a sectorial bearish trend.
Geographic diversification: This involves investing in securities from across the globe to ensure that the investment portfolio remains healthy in case of a market downturn driven by various economic factors. For instance, if an investor looks forward to investing in equities, they can allocate a portion of their capital to US stocks and, after due research, invest in some of the top-notch companies. With this, an investor will be able to offset the losses in the Indian stock market with the profits made via US stocks.
It is important to note that before investing, it is crucial to analyse and compare various investment instruments and asset classes to zero in on instruments that can ensure effective diversification. Investors should be well-versed in their investment goals and financial situation and ensure extensive market research to adopt a successful diversification strategy.
Rajiv is an independent editorial consultant for the last decade. Prior to this, he worked as a full-time journalist associated with various prominent print media houses. In his spare time, he loves to paint on canvas.
