One of the most important rules of investing is that you shouldn’t have all your eggs in one basket. Diversification is the key word when it comes to proactive financial planning and investment. The rationale behind diversification is that a variety of investments will yield a higher return collectively and you will face lower risks as an investor by undertaking different level of risks across the spectrum of these investment vehicles.
When investing in a bouquet of instruments with a focus on diversification, it’s crucial to make sure you manage the risks you are exposed to, in order to avoid gigantic losses. Not everyone has an investment acumen, but when we place our money somewhere, we expect it to perform well. We want to reap benefits from any investment we make commensurate with the risk we bear for it.
Here are a few tips to keep in mind while creating a diversified investment portfolio.
Carry a financial probe of your status
Before deciding on the avenues of investment, you need to take a comprehensive note of all your sources of income, your expenses and emergency funds. Then you can assess the financial status at which you are operating. Next, decide what your financial goals are. What are you seeking from this portfolio? Is your goal wealth creation? Are you looking for securing your family through life insurance?
Diversify across assets and sectors
Having a mix of different asset types will help you spread the risk, which is the core principle behind diversification. Choose assets that will move independent of each other, so that loss in one can be compensated with returns from another. Similarly, once you’ve decided on the assets you want in your portfolio, you can diversify further by investing in different sectors, preferably those that aren’t highly correlated to each other.
Following from the above point, you need be careful you don’t carry a huge concentration risk. Too much exposure to a particular sector or a type of instrument can be risky. This would mean that if the tide goes against your favour, it would jeopardise the entire portfolio.
How much risk are you comfortable with?
One of the most important determining factors is your risk appetite or risk tolerance. You can think of it in two ways: the amount of risk you are willing to take and the amount of risk your financial status allows you to take. It depends on your individual penchant for adventure, your investment goals and your investment behaviour. For instance, if you are worried about an income stream post retirement, you might opt for retirement plans or annuity plans, that help you build a savings corpus for your retirement or provide regular returns, in addition to a life insurance clause. This brings us to the next tip.
Ensure that you have an insurance component in the portfolio
It is important that as you manage your portfolio and your debt and other financial obligations, you also provide for the inevitable uncertainties of life. Your family should be able to stand strong, financially, in the event of your unfortunate demise. You wouldn’t want to leave them with a back-breaking debt. Therefore a ULIP or a Term plan will help you ensure financial stability for your family and dependents.
Don’t over do it
Beware of over diversification. Your aim should be to keep your holdings down to a manageable number of investments — between 20 and 30 is a good ballpark figure. If you over-diversify, you might not end up losing much money, but you may be holding back your capacity for growth.
Look for tax benefits
Finally, you should try to make the most out of your diversified portfolio and that means investing in instruments that provide tax deductions. We all know about life insurance tax benefits and how this is one of the most popular reasons why people invest in a life insurance policy.
All in all, choose wisely and think before you put your money anywhere.