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Is diversification a friend or a foe of your portfolio?

The significant part about diversification is that you stand a better chance to earn a little more than you would have, had you stuck only to one asset. Diversification mainly helps in smoothening out returns.

Billionaire and Ace Investor Warren Buffet once said that diversification is a tool for the uninformed mind. But, that’s Buffet; what works for him may not work for you. There seems to be some truth in his statement, though. Simply put, diversification means investing in assets across multiple categories such that underperformance in one asset is nullified by higher performance in another. This also works the other way around. It is essential to diversify but not overdo it. 

Many diversify by default. We all have a little gold. Some Fixed deposits, some real estate, a few mutual funds, and stocks. That way, our overall portfolio automatically gets diversified, with different types of assets. 

The significant part about diversification is that you stand a better chance to earn a little more than you would have, had you stuck only to one asset. Diversification mainly helps in smoothening out returns. 

For instance, when the equity market is heading southwards, you can still rely on other assets like rental income or gold to generate some liquidity. Likewise, when fixed deposits are not offering inflation beating rates, you can invest in  long term in equities via MFs and earn the required returns.

When it comes to Mutual Funds, investors usually tend to over-diversify. Many investors end up buying into more than one mutual fund scheme in any one category. Fund managers typically have more than one security in the mutual fund. 

Choose funds as per your needs i.e. plan in advance with time horizons and objectives assigned to your investment. For an ordinary individual investing in two Long Term Equity and Two Multi-cap funds should be enough to align to specific long-term objectives such as Planning for future educational expenses of children, Retirement Planning.

Do not invest blindly in Mutual funds

Choose funds as per your needs i.e. plan in advance with time horizons and objectives assigned to your investment. For an ordinary individual investing in two Long Term Equity and Two Multi-cap funds should be enough to align to specific long-term objectives such as Planning for future educational expenses of children, Retirement Planning. One can also consider investing in a fund that has exposure to international stocks for getting some geographical diversification over the long term and midcaps if the horizon is long enough.

One or two debt funds will help take care of short-term obligations and building an emergency corpus. 

It is essential that one keeps tabs on their performances as well. One will find it challenging to track performances and generate value as would have repetition in product portfolios if one has invested in too many funds. A balanced portfolio comprising of mutual funds will ideally have exposure to equity and debt based on individual goals. 

Real Estate

This is a tough call. Land might never depreciate, but buildings do. Property Law evolves periodically. Consolidating real estate is a good idea, especially if one holds titles to multiple properties, and those are sitting idle. 

At the end of the day, a property given out on rent is an asset, but one where you stay is a liability. Plus, maintaining the same has a cost to it. One should hence consider selling or renting out properties apart from the one where one is residing to make the most of them.

Gold

While the yellow metal is always in demand, it is best to invest in the same using Gold Mutual Funds, Gold ETF’s and Sovereign Gold Bonds. One can buy physical gold for personal consumption purposes in the form of jewellery.

Fixed income Instruments

Term Deposits, PPF, Tax Saving FD’s, Savings Bank Accounts are good to protect initial capital, but do not offer inflation-beating returns. 

A Liquid Fund can deliver better rates on capital than one’s savings account and offer liquidity as well. Savings accounts also come with their minimum balance criteria; two savings accounts are enough for one person, one that is used for investments and the other for expenses.

Experts recommend taking a goal-based financial planning approach to obtain better results on investments, and diversification certainly helps.

It is a good idea to periodically review one’s investments as goals are revised or fulfilled. Diversification can be a friend when planned and an enemy when unclear.

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