How to Diversify Your Investment Portfolio

How to Diversify Your Investment Portfolio

Diversification of Investment Portfolio is important for long term financial stability. Taking right decisions at right time will help you achieve your financial goals over long term as well. Spreading investments across various assets, within the asset classes, exploring geographic diversification, adding other investment options and rebalancing regularly are some of the diversification steps to be followed.

Let us understand How to Diversify Your Investment Portfolio in detail:

Table of Contents

What Is Diversification?

  • Diversification is the process of spreading your funds across various financial products that can help you achieve your financial goals with time
  • Diversifying of the funds can help you to avoid losses from a single investment product you use
  • For example, if you only invest in gold, and gold prices are going down for 3-4 years, you might not be able to sell it when you need funds, or will have to sell gold at low prices
  • In such cases, you should have investments in gold, stocks, bonds, mutual funds, real estate, etc. so that if any one asset class market value is going down, you can rely on other options in case you need funds. This is where diversification of your funds plays a key role.

Let us now see the steps involved in diversification.

1. Spread Across Asset Classes

First step is to identify various classes of assets based on your age, risk factor, financial goals (short term or long term) and other factors. Below are the asset classes you can invest in:

  • Stocks: These are equities in which case you invest directly in company’s shares. Stocks are highly volatile based on company’s market capitalization and earnings
  • Bonds: These are less risky compared to stocks or equities mentioned above. They give stable and low returns but are safe
  • Real Estate: The house property you buy can be considered as investment in real estate. Apart from self occupied property, you can invest in properties for rental purpose
  • Commodities: These include gold, oil and other agricultural products
  • Cash or Cash Equivalents: Finally, you can keep some funds as cash or liquid funds which are easily accessible such as savings account, fixed deposits, recurring deposits, etc.

2. Diversify Within Asset Classes

Within same asset class, you can diversify based on below points:

  • Stocks: Within equities, you can diversify the investments between large cap, mid cap and small cap stocks. Large cap stocks include companies which are ranked up to 100 based on market capitalization. Mid cap stocks include ranks between 101 to 250, and small cap stocks include ranks above 250 as per market capitalization
  • Bonds: You can invest in a mix of bonds include government bonds, corporate bonds, etc. that can have different safety levels
  • Gold: You can either invest in physical gold, that requires physical handling or virtual gold which can be accumulated digitally. You can also invest in Gold ETFs

3. Explore Geographic Diversification

  • You can also invest in stocks or bonds of other countries include USA, China, Germany, etc.
  • This helps you to not be dependent on single economy of a country
  • Explore the investment opportunities in other countries using various investment apps available in today’s date

4. Add Alternative Investments

  • Other investment opportunities can be explored such as private equity, which means investing in start ups or private companies
  • Hedge Funds: These are professionally managed investment strategies managed by professionals
  • Cryptocurrencies: These are high risk high reward investing product. But this also involves taxation on profits made so you have to be careful and allocate low percentage of your investment amount

5. Rebalance Regularly

  • Apart from investing in various asset classes, you should be rebalancing the allocations made as well every 6 months to 1 year
  • The equity mutual funds that are not performing must be replaced with other good mutual funds or other asset class
  • Sell overperforming assets to make profits and buy undervalued assets to make more profits in future
  • Apart from rebalancing, enjoy your life as well and spend some funds on your own self

6. Watch Out for Over-Diversification

  • While diversification is important, you should avoid over diversification
  • Some of you might make mistake of having too many stocks or mutual funds in portfolio, that may not be necessary
  • Some of the mutual funds may have same set of companies in their portfolio, so if the market are going down, all those mutual fund returns will also go down, hence over diversifying or investing in same class of mutual funds must be avoided
  • Don’t get overwhelm and follow investing rule such as 100 minus age percentage to invest in equities and the rest in bonds that are more safe as far as returns are concerned
Investing Allocation in Equities = 100 - Age
If age = 30 years
Equity allocation should be = 100 - 30 years = 70%
  • Above formula can help you to safely allocate in equities based on your age
  • As you age increases, the allocation to equities must decrease to follow safe investing rules

Conclusion

So these are some steps to follow for diversification of your investment portfolio and the importance of same. While it is important to diversify, make sure you are not over diversifying as it can lead to reduced profits from asset classes. And remember that it is the continuous process and you must review the portfolio regularly every 6 months to 1 year.

Remove the underperforming assets and replace them by good performing assets. Also allocate the funds based on your age.

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