The Importance Of Diversifying Your Investment Portfolio
Visualize yourself in a supermarket. You’ve been thinking about doing groceries for 2-3 days. You’re wearing something comfortable. You have a list in your hand, on your phone, or have certain things in your mind. Now, have a look at your basket. How does it look? Milk, muesli, shampoo, fruits, moisturizer, etc. Quite colorful, with a lot of variety, one thing over the other. Blue, white, pink, red. Right?
Now, think of this basket as your investment portfolio. Diversified, full of variety, one over the other, you have an idea of what is where but not precisely, probably colorful! Let us discuss the diversification of investment portfolios in detail.
Diversification of your investment portfolio:
Putting your money in different channels, asset classes, or mediums within the same asset classification is the diversification of your financial portfolio.
Take the same example as earlier. Visualize your shopping basket again. This time, think of it as only white color or just one pack of a product. Now, that is correct too. There is nothing wrong with it. But this time, all your needs are not satisfied. This one product is not going to fulfill all your monthly needs. You just ran out of this product; this is why you’re buying it. But as said, you cannot run on the same. You need to add more color and variety to your basket. Now, let’s see how doing so would benefit you.
Advantages of diversifying your portfolio~
- Risk Management: Remember the saying, “Don’t put all your eggs in one basket.” Again a basket! The reason behind this saying is that if the basket falls by mistake, you don’t break all your eggs. You still have some good ones left. The same goes for putting your money in different asset classes. If one of the vehicles doesn’t perform well, you still have regular returns from other sources.
- Financial Progress: If you allocate your money to various sources, then no matter what, one alternative will give you regular or higher returns. So, the growth prospects are higher with diversification.
- Something to fall back on: Let’s just all agree it helps to have a plan B. And with diversification, you don’t just have that security that you will get regular returns; you will always have something to fall back on.
- Higher risk-taking ability: When you have security on one end, it automatically reflects on another. Thus, when you have regular returns coming in from multiple sources, even if you are falling short on other ones, you will still have that sense of security which will help you take higher calculated risk wherever needed.
Now that we know the benefits of diversification, we should also consider the other side of it, the risks associated with the diversification of your portfolio. Let’s move to our next section.
Risks associated with diversification of your portfolio~
- Not everyone is an expert: Investments are a world of their own. Each asset classification comes with its own set of rules & compliances. To make the most of each asset and earn the maximum, we need to have an intensive understanding of each asset. Otherwise, we need to hire an expert and pay them to do the same. So that is a limitation on its own.
- Increased scope for mistakes: They might say The more, the merrier. But it necessarily doesn’t apply to diversification. When getting the hang of a single investment is so complex, leave alone investing in multiple asset classes. Thus, diversification naturally increases the scope of making mistakes. And a silly mistake might cost you a fortune sometimes!
- Tax implications: Where taxes are a complex phenomenon on their own, the tax implications proportionate to the diversification make it more complicated. And for a regular client or for someone who is just looking to make more money has to sign up for this additional headache unnecessarily.
These are the limitations that come along with diversifying your investment portfolio. Now that we know what portfolio diversification means, why we do it, and the merits and risks of portfolio diversification, we should next see how diversified our portfolio should be.
How diversified should your portfolio be?
A generally accepted good way of allocating funds is subtracting your age from 100 & whatever remains should be the stocks’ percentage in your portfolio. For example, if you are 20 years old, then 100-20 is 80. According to this way of fund allocation, you should hold 80% of your capital in the stock asset class, and the rest should go into the bonds classification. On the other hand, 65-year-olds should decrease their risk exposure; their stock-bond allocation would be 35:65.
But as they say, one size doesn’t fit all. The same goes for diversification as well. So, to answer the question of how diversified your portfolio should be, the ideal answer would be to find an equilibrium between your desired returns and how many investments you can manage. Thus, whatever suits your profile is how diversified your portfolio should be.
So, we have covered nearly all the aspects of your basket. Now, have you ever wished there was something that could help you assess the risk associated with your portfolio or something that could give you a picture of what is in store for your investments after a year or so?
Well, you have arrived at the right place. https://calculator.secvolt.com/ can be your solution if you want. The purpose of this premium risk assessor is to give you a clear picture of the inherent risks associated with your portfolio. When you enter your details, you don’t just assess the risks but also see what returns your investments could gain. The tool shares a detailed report of the same with you to serve you the best.