A sound
investment idea is to invest in a diverse range of assets. This way, you’ll
share the risk of any one type of investment going down. For example, if you
have 10% of your money in cash and 90% in stocks, then you’ll only lose 10% if
there's a crash in the stock market However, this strategy can be tricky for
some investors. That’s because many people aren’t comfortable with taking risks
and want to be sure that they won’t lose money on their investments.
What is a portfolio and why should you care?
A portfolio is a
collection of different investments that your portfolio manager will manage for
you. A portfolio manager decides which assets to invest in and then makes a
plan to buy or sell these assets in order to meet your financial goals. The
following is a list of assets that a portfolio manager might choose to buy and
sell: Stocks Bonds Real estate Precious metals Videogame-related securities
General equities Money market funds Other The list above only represents a
fraction of the assets you can invest in. If you have a lot of money to invest,
it’s possible that a portfolio manager might even buy an entirely different
type of asset than what you selected.
What are the different types of portfolios?
You may have
heard this question before: "What is the difference between a stock market
portfolio and a dividend portfolio?" I guess you can figure this out by
reading this article, but I thought I'd make it a bit easier for you.
Why diversify?
Investing in a diversified portfolio has a few advantages. It helps you spread your risks and
reduces the impact of any one position by limiting your exposure to it. When a
particular investment falls, the other positions in your portfolio are
cushioned from losses. That’s why this type of investment has a reputation for
stability. Diversified portfolios may sound boring, but they do contain
high-quality investments. For example, if you have 10% of your money in cash,
you’ll have more funds available to invest in stocks. That’s because the more
money you have in cash, the less the portfolio gains if any one stock
outperforms the other stocks in it.
The risks of investing in a non-diversified portfolio
Let's say you’re
an investor who's worried about this risk, but still wants to invest in the
stock market. You could split your money between these three options, known as
the 'Risk Appetite Approach'. You might invest 10% in cash, 60% in stocks, and
10% in commodities. These are all liquid, easily exchangeable assets, so you
won't have to sell them at a loss. However, this will certainly mean a few
sleepless nights every time your portfolio falls in value. If the stock market
falls, you could end up losing your entire investment. On the other hand, if
the stock market rises, then your investments will jump up to an amount that
you're comfortable with.
How to build a diversified portfolio
SEBI has come up
with guidelines that are useful for anyone interested in building a diversified
portfolio. Let's explore them. Don’t put all your eggs in one basket The most
common mistake investors make is placing all their eggs in one basket. These
investors want to invest all their money in the same stock or the same
investment scheme. However, this isn’t a good idea. While diversification isn’t
just about placing all your eggs in one basket, it’s also about not
over-diversifying. For example, if you invest in stock such as HDFC Bank, you
don’t want to place all your eggs in one basket. On the other hand, if you
invest in stock such as Reliance Industries, you don’t want to place all your
eggs in one basket.
Rule of thumb for building your diversified portfolio
You could choose
an asset allocation of 80% to 20% stocks and 80% to 20% bonds. Select your
asset allocation based on your risk profile. Here is a quick guide to consider
before picking your investments. Long term risk profile If you’re very
conservative and want to invest in safe investments like bonds, then 80% to 20%
bond is a good solution. However, in the long run, high-interest rates can
work against you and not give you the best returns. Medium-term risk profile
For someone with a medium to long-term horizon, the best asset allocation would
be in high-risk assets.
Diversifying with stocks, bonds, and cash
Source:
Shutterstock The safest way to invest is to spread your money over various
asset classes. Doing so can reduce the risk of one investment sector suffering
an unexpected dip. For example, in the worst-case scenario, if you invested all
your money in a stock market-focused fund, you could have seen 100% of it wiped
out. You may also invest in gold, which has traditionally served as a hedge
against market volatility. That’s because its prices don’t always move in sync
with stocks. Furthermore, you can spread your money across different asset
classes via traditional savings accounts, as well as exchange-traded funds
(ETFs). While the latter is ideal for higher levels of risk, it does come at
the expense of transaction costs.
Diversifying with commodities, foreign currencies, and gold
We want to put
your money in assets that are considered safe and that we can trust, like gold,
foreign currencies, and commodities. For example, if you have 10% in gold and
90% in stocks, you’ll only lose 90% if stocks plummet (but you’ll keep your
gold). Gold is also considered a long-term investment, which means that it
can only be sold for its current value, so it’s a good way to store value for
your long-term needs. Gold and foreign currencies are also both considered safe
by financial authorities. Using Exchange Traded Funds and mutual funds An
exchange-traded fund is a tradable ETF. There are multiple ETFs for investments
in different countries and stock markets around the world.
Diversifying with real estate holdings
As the name
suggests, real estate is one of the best options for diversifying your
investments. The benefits of real estate include the fact that you won’t lose
your capital if a specific stock market plunges, and that real estate can
provide a stable source of income that might offset any losses in the stock
market. However, it’s important to note that investing in real estate doesn’t
necessarily mean buying a large property. Instead, you can buy apartments or
homes that you can renovate to sell at a higher price in the future. This way,
you can reap the benefits of a rising market without the risk of being hurt by
a crash. Investing in forex While real estate can be bought and sold, the currency
is a lot more complicated.
Conclusion
If you want to
avoid suffering a loss of capital on your investments, then make sure you
invest a portion of your money in debt and fixed-income investments. It’s
always important to manage your money with the interest of the investor in
mind.
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