How To Diversify Your Portfolio: Key Investment Strategies
Investing money in your future goals, like buying a house, children's education, retirement, etc., is crucial for everyone. However, putting all your money in just one option can be risky. What if that investment crashes or fails to give good returns? This is where diversification comes in—a time-tested principle followed by smart investors globally. Let us understand diversification in this article.
Diversification Of Investment
Diversification means allocating capital across different investment avenues instead of putting all your eggs in one basket. The objective is to reduce overall risk by avoiding concentration in any single option.
For instance, instead of investing all your money in equity, you can split it across equity, fixed-income options, gold, real estate, etc. This way, even if one asset class underperforms, others can balance it and protect your capital.
Strategies For Diversification
You can apply different strategies for your portfolio diversification according to your risk appetite. Some of the common methods of diversification include putting your money into various asset classes, diversifying within an asset class and using a systematic investment plan (SIP) for diversification. Let’s explore these methods in detail.
1. Diversification By Different Asset Classes
Asset allocation is strategically dividing your total investment amount across major asset classes like equity, debt, gold, real estate, fixed-income securities etc., based on your risk appetite, investment goals, and time horizon.
As a rule of thumb, you can allocate:
100 minus your age = % allocation to equity
And for the rest, you can invest in other investment avenues.
So, for a 30-year-old, 100 - 30 = 70% equity allocation and 30% in debt is reasonable. For a 50-year-old, it would be 50% equity and 50% debt.
The above method is used because with age your risk appetite is reduced and thus you should consider putting your money in less risky assets than the stock market such as investment-grade corporate bonds.
Also, it is observed that different assets move differently in changing economic conditions. For example, in many situations when the stock market goes down, the gold price goes up. In fact, within the stock market, during inflation, some of the shares will perform better than others such as shares of the companies involved in producing or trading commodities like oil, gold or agricultural products. Therefore, your portfolio must be diversified within an asset class as well.
2. Diversification Within An Asset Class
Even if you have decided to invest in different asset classes, you should consider diversifying within each asset class to reduce the risk further.
Let’s take the above example of equity and debt allocation. Assuming you are 30 years old, you will be putting 70% of your investment amount in equity. But in which stocks? You should not invest your whole 70% in a single share but you should further diversify it into large-cap, mid-cap and small-cap.
Further, you can also diversify your equity investment by purchasing shares of different industries. For example, considering the good economic condition and growing trends in information technology, you can consider purchasing shares of the IT and banking sectors. Not only this, you can consider investing in the stock market of different regions or countries. This way you can balance your portfolio returns by mitigating the risk of specific economic situations or geopolitical events.
3. Diversification Over Time Via Systematic Investment Plan (SIP)
A Systematic Investment Plan (SIP) is a disciplined approach to investments. Generally, SIP is done for mutual funds wherein you can decide the mutual funds you want to invest in and then invest a fixed amount at regular intervals. Since the Net Asset Value (NAV) of a mutual fund changes daily, investing through SIP provides a balanced return over time. In the long term, there will be instances when the NAV is low during your investments and vice versa. However, this fluctuation ultimately adjusts the overall return you receive.
A SIP can be done in corporate bonds as well. Grip Invest offers SIP in corporate bonds that help you diversify your portfolio returns with fixed-income securities by disciplined investing in investment-grade corporate bonds. Thus, along with SIP in mutual funds, by choosing SIP in corporate bonds you can further diversify your SIP investments in a different asset class which is non-market linked.
Read more on:
The Benefits Of Compounding Through SIPs
Let us explore the different asset classes that you can choose to diversify.
Asset Classes For Diversification
Since the stock market is highly volatile, you can consider some alternative investment opportunities to diversify your portfolio:
1. Investing In Bonds With Systematic Cash Flows
Corporate bonds are debt instruments companies issue to raise capital for business needs. They offer periodic fixed-interest payouts, usually every year. The principal amount is repaid on maturity.
Corporate bonds provide better returns than fixed deposits while offering lower volatility than stocks. Based on the company's creditworthiness, they are rated from AAA (highest safety) to D (lowest safety). Investing in investment-grade corporate bonds can offer you a high yield of up to 14%.
2. Invest In Securitised Debt Instruments (SDIs)
Securitised debt instruments are SEBI/RBI-regulated fixed-income instruments backed by assets like loans, invoices, and leases.
On Grip Invest, investors have many SDI-based investment opportunities, such as LeaseX, LoanX and InvoiceX. The main USP of these products is that they offer significantly higher returns than other similar credit-rated fixed-income products. These SDIs are rated by independent credit rating agencies and can offer you a higher return of up to 16%.
You can also read:
3. Investing In Money Market Securities For Cash
Money market securities are short-term fixed-income instruments with tenures of up to 1 year. Given their short durations, they offer a higher return on investment than savings accounts while providing the safety of the principal.
For stability and liquidity, it is good to allocate some portion of your capital to safe money market instruments like:
- Certificate of Deposits (CDs)
- Commercial Papers (CPs)
- Treasury Bills (T-bills)
- Tri-party repo on government securities
4. Invest In Life Insurance
Life insurance is not only about ensuring financial security for your family after you. Some permanent plans include a cash value feature that can grow over time, providing accessible returns and offering portfolio diversification.
In these policies, a part of each premium payment is directed into a separate account, where it accumulates tax-deferred interest. Policyholders can borrow against or withdraw this component if needed.
5. Explore Global Markets
Given their scale and scope, global financial markets, such as US markets, commodities, etc., offer tremendous growth potential. However, these markets see rapid movements and require more expertise to participate profitably.
As a beginner retail investor, starting small with low-cost options like index mutual funds and Exchange-Traded Funds (ETFs) is advisable to gain an understanding before directly dabbling in futures, options, etc., which also involve higher risks.
Conclusion
Diversifying your investments smartly across various asset categories- major classes like equity, debt, etc.- and within asset classes like sectors, market caps, durations, etc., is crucial to balancing risks and maximising profits.
Explore Grip Invest and stay updated on all relevant financial planning opportunities.
Frequently Asked Questions On How To Diversify Your Investment
1. What are the financial biases?
Some common biases include risk tolerance influenced by family background, trusting luck factor, herd mentality, recency bias, etc. Awareness of these tendencies prevents you from letting them irrationally impact your diversification strategy.
2. What is a buy-hold strategy?
Unlike active trading, the buy-hold strategy involves investing in assets for the long term, based on their fundamentals instead of trying to time markets. The focus is on allowing compounding to boost returns over time instead of churning portfolios frequently. However, periodic portfolio rebalancing is still required to maintain the desired asset allocation.
3. What is portfolio rebalancing?
Rebalancing involves realigning the asset allocation if variations emerge over time due to differing returns. For instance, if equity allocation rises substantially from 50% to 70% of portfolio value, you can redeem partial profits to return it to 50% and redistribute amounts to debt, gold, etc., to restore the original asset mix and cover the risks. This discipline is required once or, at a maximum, twice a year. Monitor every 6 months and rebalance if deviations exceed 5-10% in any asset class.
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