Any financial planner worth his salt will vouch for the importance of diversification. In fact, diversification should be regarded as one of the basic tenets of financial planning. Having the desired degree of diversification makes the portfolio a resilient one. A downturn in a given investment can be offset by the presence of another. In this article, we discuss the various means that can aid investors in achieving a desirable degree of diversification in their portfolios.
Diversify across asset classes
Firstly, the portfolio must be diversified across various asset classes. Depending on the investor's risk profile and needs, assets like equities, fixed income instruments, gold and real estate among others should find place in the portfolio.
This will grant stability to the portfolio, by making it resistant to the vagaries of the market. For example, when equity markets are at their volatile best (as they are at present, for instance), the portion invested in fixed income instruments like fixed deposits and fixed maturity plans can prove to be handy.
Within each asset class, there is a need to be diversified across various investment avenues. For example, the equity portfolio can comprise of direct equity investments, investments in mutual fund schemes and unit linked insurance plans. Similarly the fixed income portfolio can be constructed from FDs, FMPs and small savings schemes. An insurance portfolio could hold a combination of term plans, endowment plans and ULIPs.
Diversify across time horizons
Investors should hold multiple investment portfolios each catering to a distinct need and running over a commensurate time horizon. For example, typically an investor could have short-term goals (going on a vacation), medium-term goals (buying a house) and long-term goals (providing for retirement).
Each of these objectives should be backed by a distinct portfolio and the investments therein should be aligned with the time frames. Equities can account for a higher portion of the long-term portfolio given that they are best equipped to deliver over longer time frames. Conversely, fixed income instruments could dominate the short-term portfolios.
Diversify across providers/suppliers
Ensure that your investments are spread across various providers/suppliers. For example, the mutual fund portfolio should have schemes from various asset management companies. Each AMC can offer a unique investment style and process, thereby aiding the portfolio on the diversification front.
Similarly, FD offerings from multiple banks can be considered for investment. Investors should make use of the plethora of providers to their advantage, by selecting the "best-in-class" financial service providers/asset managers and in the process de-risk their portfolios.
Diversify across countries
Investors now have the option to invest globally. Domestic mutual funds have been granted permission to invest in foreign stocks. Similarly, resident Indians are also permitted to invest in assets and securities abroad, subject to the regulations issued by the Reserve Bank of India.
By adding foreign assets to their India-centric investment portfolios, investors can expose the same to a different set of market forces, thereby imparting it a unique diversification edge.
By Personalfn.com, a financial planning initiative. It can be reached at info@personalfn.com. Personalfn.com also publishes a free-to-download financial planning guide, Money Simplified. To get a copy of the latest issue - How ULIPs fit in - please click here.
