The importance of diversification in your investment portfolio

Investing is the key step to accumulating wealth for future financial goals. Investors put their money in different assets across investment instruments as per their investment horizon, risk tolerance and financial targets.

Some may want to keep pace with inflation while some save money for retirement. While goals may differ, smart investing is a balancing act between risks and rewards. You may not want to be conservative with your money so that returns outpace inflation. However, playing aggressively by putting all your eggs in a single-asset vehicle is a riskier approach.

Whatever your investment strategy might be, the aim is to maximise returns. That’s where the importance of diversification of investment comes into play. You need to have a diversified portfolio to manage your risks and rewards effectively.

Let’s understand what is the diversification of investment and how it works:

What is diversification in investing

Diversification is an approach where you put your money into different assets, or spread your investment across various instruments to minimise risks and increase returns.

Different assets such as bonds, gold and stocks have different risk levels, stability and return characteristics. The diversification strategy mixes a variety of investments within a portfolio to reduce risk.

Thus, diversification is achieved by putting money in different asset classes such as bonds, gold, stocks, real estate, or cryptocurrency or distributing your eggs to different baskets to achieve higher returns with more stability.

Benefits of a diversified portfolio

For example, if someone wants to save money for retirement, the individual will avoid investing in a single asset class like stocks or bonds. He will create a mix of these two to achieve stable returns for retirement.

Investment portfolio strategies

Experts suggest various portfolio diversification strategies for maximising returns and lowering risks. However, it is important to know about the risk of investment in an asset before making a decision.

• Stocks/equities: Stocks or equities allow investors to have some ownership in a company. Stocks produce high long-term gains but these are volatile and give low returns when the economy is not performing well.

• Bonds: Bonds offer stable and fixed returns over time and generally carry low risk, especially government bonds. However, the returns are limited when an economy is expanding or performing well.

• Cash or cash equivalents: Cash or cash equivalents such as liquid assets help meet the emergency needs of an individual. However, these carry both low risk and low returns.

Diversified Investment is allocated to these assets as per the risk and returns offered by these vehicles.

Conclusion

Portfolio diversification brings great benefits of stabilising returns, managing risk and making investing more fun. While investing always carries a risk these can be managed by allocating resources mindfully. It is also said that diversification can lead to lower returns as resources are divided across assets which behave differently at a certain point in time. But throwing all your eggs in a single basket is not a wiser decision.