Diversification across multiple asset classes helps protect an investor’s capital if one sector of the market does not perform well
By Priyanka Jain
Without an investment portfolio in place, investors might be unprepared for several major milestones in their life. A portfolio with a diversified mix of investments not only helps to protect the invested capital but also allows positioning it to earn desirable returns.
By developing an investment portfolio that centres around income securities, individuals can supplement their income in the future. For instance, when you dedicate a fraction of assets to dividend-paying stocks, you may create a stable income stream. Stock dividends are not usually assured but certain companies make uninterrupted payments over time. You can also invest in bonds to generate income, as these fixed-income securities generally make regular interest payments over the tenure of the investment.
How to build a diversified portfolio
Investors must judiciously allocate their capital to reap the benefits of being exposed to the risk of the financial markets. Diversification across multiple asset classes helps to protect an investor’s capital if one sector of the financial market does not perform well.
Investors have three levels of risk tolerance— low, moderate and high. If you need your capital in a few years and cannot stomach the ups and downs in the market, you have a low-risk tolerance. On the other hand, if you do not need your money for, say, 15-20 years, you would have enough time to wait out a drop in your investment value, before the market bounces back.
Benefits of a diversified portfolio
Reduces the impact of market volatility: A diversified investment portfolio helps minimise the overall risk associated with the portfolio. As investments are made across varying asset classes and categories, the overall impact of market volatility tends to decrease.
Helps seek advantages of different investment options: By choosing different investment options such as mutual funds, ETFs, fixed deposits, etc., investors can enjoy the unique features of each instrument and mitigate risk. For instance, by investing in fixed deposits, an investor can enjoy fixed returns at lower risk, but with equity mutual funds, she has the potential to earn relatively higher returns as the risk is equally high.
Helps to preserve capital: Diversification allows investors to achieve their investment goals by limiting exposure to particular investments.
Helps manage risk: At the core of a diversified portfolio are investment options that react to specific economic conditions. Investors will get weighted average returns on their underlying securities and would not be fully exposed to the volatility associated with a particular asset.
Offers peace of mind to investors: When the total corpus is divided among a variety of asset classes and categories, an investor will not be worried about the performance of the portfolio.
Achieving long-term financial goals requires balancing risks against rewards. While there are several ways to invest, there is no ‘one-size-fits-all’ approach to investing. So, choose the right mix of investments for your portfolio and rebalance and monitor your financial choices periodically. Remember, your investments should align with your financial goals, risk appetite, and investment horizon.
The writer is assistant professor, Amity School of Insurance, Banking and Actuarial Science
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