- Date : 18/09/2023
- Read: 3 mins
Make sure your portfolio has a good mix of asset classes, largely insulating it from certain types of risk.
Emerging Markets can be a good investment opportunity, especially for investors with a higher risk affinity. They have higher volatility, leading to higher returns but with a higher potential for losses as well. In this article, we will discuss how diversification of portfolio works and how you can diversify against the aforementioned risks.
- Diversification is the process by which you spread your investments across companies, sectors, countries, etc.
- Diverse portfolios will generally have assets whose movements are less positively correlated.
- Diversification leads to an increase in the complexity of portfolio management
- Diversification lowers the chances of a complete wipeout of your portfolio
What is Portfolio Diversification?
Portfolio Diversification is the process of spreading your investments across various asset classes. It is done with the objective of increasing risk-adjusted returns. Diversified portfolios will have assets which are somewhat negatively correlated. This offsets the poor performance of one asset with the good performance of another.
How Diversification of Portfolio Works?
A diversified portfolio will have a few different types of asset classes. Described below are some of the common ones:
Stocks usually have a higher yield than other asset classes, while also having a higher volatility.
- Diverse Funds
Some mutual funds/ETFs take the onus of diversification on themselves under certain bounds, which will be detailed in their scheme brochure.
- Bonds and Debts
These instruments provide investors with fixed returns on their investments and are generally backed by governments or huge corporations, reducing the risk and returns.
- Real Estate
This asset class is known to appreciate over time, with high income potential. The downside of owning physical assets like these is the cost of upkeep.
- Savings Accounts
These provide consistent returns over time and have the lowest risk associated, while providing the lowest returns out of all the asset classes mentioned above.
Effect of Diversification on Portfolio Risks:
Suppose there are two portfolios, both with investments worth 1,00,000 Rs. One has investments evenly spread over 5 assets while the other has invested all the money in one of those five assets. If that asset suffers a loss of 10%, the diversified portfolio suffers a loss of 2,000 Rs while the other portfolio incurs a loss of 10,000 Rs.
Ways of Diversifying Effectively:
You can diversify portfolio based on certain parameters, like:
- Asset Class
- Geography or Market
- Market Cap
Diversification is a seemingly daunting task, but it is also a necessary one to ensure the highest risk-adjusted returns possible. Seek help from professionals for this if needed.
Disclaimer: The information in this article is intended for general informational purposes only and should not be construed as financial advice. Readers are advised to do their research and due diligence before making financial decisions.
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