Monday, July 26, 2010
How diversified portfolio helps you get higher returns?
Diversification is a strategy to reduce a portfolio's exposure to risk by investing across different asset classes. Investments like stocks, bonds and real estate respond differently to different economic situations. So, if an asset class is not performing well, your entire portfolio is not affected.
The aim of a well-diversified portfolio is to mitigate risk, yield stable returns and provide ample liquidity. It is unwise to put all your eggs in one basket. Diversification involves investing your money across various asset classes.
Here are a few pointers for a well-diversified portfolio:
The aim of a well-diversified portfolio is to mitigate risk, yield stable returns and provide ample liquidity. It is unwise to put all your eggs in one basket. Diversification involves investing your money across various asset classes.
Here are a few pointers for a well-diversified portfolio:
Balance investments:
Have you invested heavily on a particular stock? If so, you are taking a tremendous risk. Reduce the size of any large investment that could pull down the performance of your entire portfolio.
Tread with caution when it comes to adding risky investments to your portfolio.
Balance risk and goal:
Your goal, risk appetite and investment objectives determine the extent of diversification. Diversify across different asset classes. Is your portfolio over-weighed by bonds?
Consider increasing exposure to other asset classes like stocks, precious metals and real estate. A well-diversified portfolio will not be drastically influenced in value and returns under fluctuating economic conditions.
Diversify within asset class:
Take for instance stocks. You can invest across different sectors like FMCG, pharma, bio-technology, energy, BFSI and utilities.
So, if banking sector is undergoing a lull, it wouldn't adversely reflect on your portfolio performance. Similarly, invest across different market caps.
Allocate percentage:
A general guideline is to allocate the same percentage of your corpus as your age to conservative investments like bonds and the remainder to riskier assets like stocks. If you are 30 now, invest 30 percent in bonds and the rest in stocks.
This guideline merely indicates that you must invest in high risk, high returns instruments when young and migrate to low risk, stable returns as you grow older. Professionally-managed mutual funds are a good choice for investors who do not have time for market research.
Dangers of over diversification: Over diversification could start adversely impacting your portfolio's returns. If you are invested in stocks of 10 different companies that are from across different sectors that have low correlation, your portfolio is well-diversified.
On the contrary, if your portfolio contains stocks of 25 different companies, your portfolio could be plagued by excessive diversification. While you wouldn't be impacted by a fall, you wouldn't gain much either in good time. Further, it is difficult to manage and keep track of numerous stocks and investments in an over-diversified portfolio.
Tread with caution when it comes to adding risky investments to your portfolio.
Balance risk and goal:
Your goal, risk appetite and investment objectives determine the extent of diversification. Diversify across different asset classes. Is your portfolio over-weighed by bonds?
Consider increasing exposure to other asset classes like stocks, precious metals and real estate. A well-diversified portfolio will not be drastically influenced in value and returns under fluctuating economic conditions.
Diversify within asset class:
Take for instance stocks. You can invest across different sectors like FMCG, pharma, bio-technology, energy, BFSI and utilities.
So, if banking sector is undergoing a lull, it wouldn't adversely reflect on your portfolio performance. Similarly, invest across different market caps.
Allocate percentage:
A general guideline is to allocate the same percentage of your corpus as your age to conservative investments like bonds and the remainder to riskier assets like stocks. If you are 30 now, invest 30 percent in bonds and the rest in stocks.
This guideline merely indicates that you must invest in high risk, high returns instruments when young and migrate to low risk, stable returns as you grow older. Professionally-managed mutual funds are a good choice for investors who do not have time for market research.
Dangers of over diversification: Over diversification could start adversely impacting your portfolio's returns. If you are invested in stocks of 10 different companies that are from across different sectors that have low correlation, your portfolio is well-diversified.
On the contrary, if your portfolio contains stocks of 25 different companies, your portfolio could be plagued by excessive diversification. While you wouldn't be impacted by a fall, you wouldn't gain much either in good time. Further, it is difficult to manage and keep track of numerous stocks and investments in an over-diversified portfolio.
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