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Portfolio Diversification to Manage your Investment Risk

You must have heard the famous saying in your life – Do not put all your eggs in single basket! This fact is very true, especially when it comes to investing and diversification is a real key to successful investing. It is one of the important tools in your investment arsenal which lets you to take calculated risks in order to build your wealth in risk-free way. The research has shown that investors who have diversified their portfolio usually earn more consistent returns on their investment than individuals who invest in only one product. Go through following points to know about importance of diversification and how to manage your risk by diversifying your portfolio –

Asset Allocation

Asset allocation is important tactic followed in portfolio diversification. By having products of diverse investment classes in your portfolio such as stocks, mutual fund, bonds, gold, real estate and commodities, you can protect your investments from losing their value in both short and long term.

Pick Your Stocks Judiciously

Equity products possess potential of delivering high returns, but don’t put your entire money in only one sector or one stock. You can think of creating virtual mutual fund by investing in different companies from diverse sectors. You can choose handful of companies which you trust and perhaps you use their product in everyday life. Most of the individuals believe that investing in companies which you know is a very average approach but it can be highly safe strategy which can give you stable returns in long term.

Think of Index or Bond Funds      

Make sure to add fixed income or index fund to your investment kitty. Investing in securities which track different indexes can develop a most effective diversification strategy for your portfolio. By considering some fixed income solutions, you can also hedge your investment portfolio against volatility in the market.

Deciding Number of Asset Classes

The exact number of asset classes needed to achieve the ideal level of portfolio diversification mainly depends on the degree of correlation among asset classes which are added in your investment universe. The lesser the degree of correlation, the higher the potential of diversification and lower the number of asset classes needed to achieve an ideal level of portfolio diversification.

Limit your Exposure to Highly Risky Investments

Be careful when investing in ‘junk’ bonds, emerging market and volatile commodities such as silver and oil. Before taking a vital decision of adding these highly volatile investments in your portfolio understand overall risk behind investing in such products. Do some research or seek help from professional financial advisor to balance your portfolio properly.

Avoid Over Diversification

Over-diversification may arise when two or more investment assets overlap. It can create problem if it’s done unintentionally. Most of the investors allocate higher exposure to few sectors and try to create over-diversification by creating overlap in the portfolio. Though this technique is contrary to basic financial theory, premeditated overlap is matter of investor’s choice and most of the investors consider it as an effective investment strategy.

Rebalancing is Essential

Diversifying your investments is alone not enough. Once you have selected your investment avenues, keep track on it by doing periodic checkups. If you fail to rebalance your portfolio at right time then a volatile run in market may expose your portfolio to risk level which is inconsistent with your financial objective and strategy.

Moderate the Impact of Individual Asset Class

Moderating the impact of individual asset classes on your portfolio is one more advantage of portfolio diversification. This is required because lower the variance of your investment portfolio, higher the certainty of its return over the period of time. It is extremely important as you may have to liquidate all or some part of your assets for emergency reasons.  So the low variance will definitely reduce your panic and stress related with investments.

Selecting Right Asset Class

It doesn’t matter how you define your asset class, the crucial thing is that you must hold variety of investment products which are not correlated with each other. Assets which not correlated with each other are referred as complementary products as they complement with one another forming a unit which is less susceptible to market risk.

Keeping Feasible Expectations

The common fact of the life is that everything has its ups and down and stock market is not exception to this. So work out what kind of returns you are expecting in stable as well as volatile economy. With a well diversified portfolio in hand, you can expect returns which range from conservative 5% to aggressive 15%.

Spread your Risk

Spread your risk geographically so that you will not be susceptible to natural disasters which will impact your business at the same time. Not all geographic locations react in a similar way to changing market conditions. So in order to reduce your location specific risk, you can add some international investment products in your portfolio.

Conclusion

Having multiple products in your portfolio can’t prevent one of your holdings to go into bankruptcy. But you can definitely lower the potential loss in relative terms because multiple products in your portfolio means less risk attached to each one of them. Investing can be a fun as well as rewarding even in the worst times, if you follow disciplined approach and stick to diversification. Above mentioned suggestions will definitely help you to get most out of your holdings by diversifying your investment in different sectors and by safeguarding your investments against market volatility.





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