Eggs and financial investments: these are two things that don’t have anything in common. Yet, when it comes to investing, there is a very popular saying that connects the two: Don’t put all your eggs in one basket. This simply means that in case you invest all your money in a single stock or a single industry, you are exposed to a greater degree of risk. In this article, let’s discuss how diversification of your portfolio plays a very important role in financial planning.
What is diversification?
Diversification is an investment technique where you invest in a range of different financial instruments, industries and other asset classes. The idea behind this type of investment is to reduce the overall investment risk and prevent a major loss in the portfolio due to the poor performance of a single security.
Why you should diversify?
1.Lower your investment risk
The most important reason to diversify your portfolio is to reduce your overall investment risk. Imagine you invest all your savings in a single stock from the mining industry. You hope to earn high returns from this investment.
Let’s assume that for some reason that the stock in which you invested loses 60% of its value over the course of a year. This means that you have lost 60% of your portfolio value. But what if the stock made up just 5% of your portfolio? A downslide in the stock does not affect your overall portfolio value in a big way.
2.Manage market risks
Many times, market conditions could impact the performance of an entire sector. The dot-com bubble for example, had an impact on all technology companies in the financial markets. When you invest in more than one sector or industry, you can spread the risk and ensure that a single event does not have a major impact on your overall portfolio.
3.Take advantage of different markets
In this current day and age, you don’t have to restrict yourself to the Indian markets alone. Through diversification, you can explore different financial markets all over the world. This can include the American, European or Asian markets. Different markets may experience different growth patterns. By spreading your investments across different markets, you can take advantage of the growth opportunities and earn higher returns.
4.Explore alternative assets
Stock market diversification is very important. But diversification does not have to end there. There are a lot of different assets you can explore and include in your portfolio. You can consider investing in real estate, bonds, money market instruments or commodities. This gives you greater exposure and better understanding of different money markets. The more you know about these avenues, the better you can invest.
To maintain a healthy and balanced investment portfolio, diversification is very important. You don’t have to be too worried in case of every market crash or downturn. A diversified portfolio is not only good for your financial health; it is probably good for your personal health too.