“Diversification” is one word that gets thrown around quite a bit in the investment world. How much portfolio diversification should you aim at achieving? In this post, we would like to point to some common errors and myths regarding this diversification
#Myth: You should invest in all asset classes
Many financial advisors would recommend diversifying your portfolio to include all asset classes:- Equity, bonds, Money market or cash equivalents, Real Estate and Commodity (primarily gold). However, blind diversification unnecessarily spreads your capital without yielding as much return. Consider this: An investment in Real Estate in a relatively undeveloped Real Estate market like India might not be the best course of action for everyone. The reasons are high entry barrier, the lack of real estate market instruments like Real Estate Investment Trusts ( the ones that are available are not attractive for tax reasons). You should assess the market before you venture into diversification.
#Myth: Conventional asset classes are much better investments
A generation ago, people considered gold to be the only safe and reliable investment instrument. Even today, many people recommend investing in Gold predominantly. However, we have data to prove that Gold as an investment instrument is a very bad choice. For example, equity markets have consistently outperformed Gold as far as returns are considered.
#Myth: Traditional Instruments are all bad
This is a continuation of the earlier point. Though we did say that Gold is a bad investment choice, we did not say that you should not include Gold in your portfolio, at all. This is because every investment is not made with return alone in mind. Gold provides a good hedge against inflation. Even though the gains that you derive out of the yellow metal are always out of capital appreciation alone, Gold has been shown to be a reliable instrument when all else fails. When the market goes down in confidence, gold gains in it. You should assess an investment instrument based on its application to your investment goals and not because someone else said it is a bad choice.
#Fact: You should understand what class your investment falls into
These days people have started buying bitcoins. Bitcoin is a cryptocurrency. However, it is important to understand that the majority of the people who buy bitcoin do not buy it as a medium of exchange but as a hedging instrument. It is bought as an investment and not for the primary purpose it is meant to serve. When putting your money into something, it is extremely important that you are clear about your goals. Without this, you might as well throw your money into the ocean.
#Fact: Stocks can be as assured an investment as any if you know what you are doing
It is a myth that FD’s are the safest investment instrument out there. Did you know that the deposit guarantee that you have for your FD’s in any bank is one lakh? That is if the bank goes bust with your 10 lakh Fixed Deposit, you are going to get back only 1 lakh.
The same way, even though the market is highly unpredictable it is a fact that you can be assured of future returns from shares. However, this cannot be based on guesswork or hearsay. Your choices have to be backed by intelligent decision based on proper analysis of the fundamentals of the companies. The larger number of variables that you are able to remove from the equation, the greater the probability of you getting handsome returns.
Diversification of your portfolio is very important. However, diversification shouldn’t be the end. Your end goal is to get maximum returns from your capital with minimum risk. For this, you need to make decisions based on your end goals.