Diversification relates to spreading investment money across many different types of assets. Investors can reduce their exposure to market risk and make their portfolios more stable this way.
Apart from minimising portfolio risk, diversification also helps to increase profitability. It is a handy tool for making more money from investments. It offers an investor exposure to many stocks at convenience and lower cost, managed by portfolio managers.
For long-term investments, a diversified portfolio is needed. With a well-diversified portfolio, an investor can be sure that in the case of poor performance of a single asset category, savings are not going to take many hits.
In the case of mutual funds, diversifying the portfolio helps to achieve risk-adjusted returns. The equity markets may be low, yet systematic investment planning (SIP) investments tend to yield higher returns.
A point to remember is that investing in every mutual fund category is not the right way to diversify the investment portfolio. Especially in cases where an investor is investing a modest amount. Also, with over-diversification, an investor runs the risk of gaining modest returns.
Goal-based investing is the key. For instance, in case of mid-term goals, to be achieved in say five years, an investor can look at debt mutual funds. Then, for long-term investments, consider investing in equity mutual funds. Essentially, mutual funds should match the risk profile of any investor.
Remember, diversification is not a complete solution to guarantee losses won’t occur, but it can make them less likely, though.
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.
