Though there’s always a section of early birds who start investing their savings before most, they are far outnumbered by the vast majority of people that don’t start investing until later on. This is especially common with millennials, the financial trend breaking group of people born between 1981 and 1996, who account for 70% of India’s national household income, not to mention they make up 46% of our country’s working population.
This in no way means that this group of people is not serious about investments. Despite stock markets falling 40% due to COVID-19, discount brokers in the country saw account openings increase by almost 70%, 80% of which belonged to millennial investors. This is no surprise since the majority of millennials actively wish to know more about investments, especially how to invest in mutual and equity funds.
Before we delve into that rather heavy and sensitive topic for new investors (which we will very soon), we wanted to talk about portfolio diversification, so you can take it into account as you start investing rather than afterwards.
Your investment portfolio is simply the collection of investments you’ve made, whether it’s in fixed deposits or stocks. What portfolio diversification is and why it should be done are related answers so we’ll convey the overall gist here.
Basically, when it comes to your investment portfolio, you don’t ever bet on just a single horse in the race. That way, should a single horse fail, the other horses you’ve bet on can make up for the damage you incur.
For example, if you had invested all your savings in the travel industry before COVID-19, you would have potentially lost a majority or all of your capital whereas if you had invested in both travel and edtech, you would have lost what you had invested in travel, but this would be mitigated by the returns you’re getting from your edtech investment. Properly diversifying your portfolio in this way will prevent you from losing out on all your investment capital. The whole object of the game is to diffuse risk (risk minimization).
There’s a couple of ways to go about this; the first one is asset allocation. This essentially means reducing the risk of your entire portfolio by investing in a wide array of assets, like real estate, gold ETFs, bonds, and mutual funds, in an organized and systematic way, rather than investing in just a single one of these assets.
How you allocate these assets is very dependent on your risk appetite or the amount of risk you are willing to take when investing. As we mentioned in our Beginner’s Guide to Investment, the return on your investment tends to proportionate to the risk you’re willing to incur. If you’re not consulting a professional, a couple of things to think about are how much you have in savings, how much impact your savings can afford to take in the case of a bad investment as well as how long it would take to recover that capital.
Another way to diversify your portfolio is to invest in various options within a certain asset class. So, for example, if you’re investing in stocks, you should be careful not to concentrate all your investments in just one sector. Even within stocks, invest in different segments that show good potential and possibility of high returns.
In fact, even within a certain segment, it is possible to diversify your investments. As per the guidelines of the Securities Exchange Board of India (SEBI), companies are classified by their market capitalization (the market value of a company’s outstanding shares) as large-cap (high market value), mid-cap and small-cap (low market value).
Investing in a large-cap company has different pros and cons to investing in a mid or small-cap company since they are in different stages of growth and change. Large-cap company stocks are well established and stable but don’t have much potential for growth on investment whereas small to mid-cap stocks are more volatile since they’re newer to the market, but also have much higher potential for growth. Investing in an array of these in a given segment rather just one will also diversify your investments significantly.
The best thing about diversifying your portfolio is that you are protected by short term volatility. When you’re focusing on taking a systematic approach to your investments, you’re less likely to do short term investments based on temporary market trends. Diversification is an organized approach so even what appear to be high losses in the short term can be mitigated in the long run so it’s nothing more than just a temporary glitch since your goal is to achieve long term growth and returns.
One final benefit of portfolio diversification is that you end up growing your skills as an investor. Having invested in a wide range of stocks and assets will give you a well-rounded view of the economy and deepen your insights on what kind of investments work best for you. You’ll only keep growing and get better ideas as your returns grow.
Remember that the market will always be dynamic, but diversification for the long haul will see you through all the ups and downs.