Diversification of the wealth portfolio is necessary and at the same time under-appreciated. Investing in assets classes with low correlations offers the benefit of a protected down side even if it means moderated returns on the up side.
The most elementary diversification is between physical assets (real estate, gold and commodities) and financial assets (primarily fixed income securities and equities and derivatives thereof).
Real Estate has traditionally been the favored route for Indian investors. While rental yields on property are low (averaging between 3 to 4% in most cities), it is both the emotional value of owning property as well as the scope for capital appreciation that has been the main attraction. The clampdown on black money has impacted transaction volume in this segment lately. Additionally, attractiveness of other avenues as well as investor savviness has helped pull share of wallet away from real estate.
Apart from owning physical property, the other nascent option for investing in real estate is through Real Estate Investment Trusts (REITs), which are effectively pooled funds investing in real estate themes. For HNIs, there is also the option of private equity funds specializing in real estate investments.
Related: Should I rent or buy a house?
Gold isn’t just an investment for many Indian investors- A store of value, a hedge against inflation, even emotional succor- gold serves many difference purposes. As an investment, gold jewelry has limited appeal since the appreciation and liquidity on it is low. Gold coins and bars are much more liquid and assuming they are quality stamped, can be sold very easily at transparent market prices. Physical gold however carries risks of security as well as quality. The other route in such a case is Gold ETFs, which have proven immensely popular due to their reliability, liquidity and transparency. They are quoted on stock exchanges, held in demat form and can be bought/sold in the same manner as equity shares.
Till recently, investors could take exposures in commodities only through physical holdings. Indians now have the option to participate through commodity derivatives as well. This provides a very effective diversification option that is largely uncorrelated with the others.
Exposures can now be taken in wide variety of commodities beyond just gold and silver – exchanges like MCX and NCDEX offer contracts on agriculture, metal and energy commodities.
Investing in commodities makes sense for speculators as well as fundamental investors. Commodities are also easy to understand since the basic principles of demand and supply determine pricing and volatility too is low compared to equities or fixed income securities.
Equities remain one of the most popular and widely researched investment option for retail investors. Investment in equities can take one of many forms:
Diversification themes within the equity class can take many forms, with each option having distinct returns, volatility and risk prospects.
Fixed income investment options have moved beyond traditional fixed deposits. Now, an investor has myriad options depending on what kind of exposure is desired - from money market instruments of short-term maturity to corporate debentures/bonds of medium maturity to infrastructure bonds that stretch up to 20-25 years. Even more simply, an investor can opt to invest in an income or liquid mutual fund scheme that assimilates the returns of the underlying securities that it holds.
Diversification, when done sensibly, helps an investor to balance out risk and optimize returns. Investment in uncorrelated asset classes protects the downside while providing an opportunity to gain the upside of varied asset classes. The traditional adage ‘don’t put all your eggs in one basket’ probably holds truest for investments.
"Knowing yourself is the beginning of all wisdom"- Aristotle -
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