Diversification refers to combining a wide variety of investments within your portfolio as a risk management strategy. Consider diversifying your portfolio across different asset classes, sectors, industries and companies, instead of investing only in one.  Based on this approach, an investment portfolio with a variety of assets produces on average a higher long-term return along with relatively low risk.

Why is Diversification required?

Market volatility makes diversification essential to mitigate the risk. It’s difficult to choose which asset class will give you the best return with the least risk when the future is uncertain and the market structure is always changing. All your savings would have been lost in a minute if you invested them in a single fund that crashes. Instead, diversifying your investment will help you cope with market volatility as the risks are spread across a variety of different assets.

Diversification Strategy

Investing your savings into different types of assets is the essence of diversification. An asset class is a group of investments with a similar return and risk profile. Different asset classes do not peak and drop at the same time, so diversification helps to protect you when the market fluctuates.

Investing in Stocks and Bonds

The amount of stock versus bond investments is one of the main topics of investment debate. The return from stocks is greater, but volatility is higher, whereas the return from bonds is lower, despite being less volatile.  People who are younger and can invest for a longer period of time should invest in stocks, while people who are closer to retirement or in retirement should consider bonds for a fixed income with some security.

Investing in Industries and Sectors

You can also categorize stocks by industries/sectors, which are great for diversifying your investment. Diversifying your investment can be done through various industries, such as –

• Financial Services
• Health Care
• Real Estate
• TeleCommunication
• IT
• Gas & Petroleum
• Tourism & Hospitality
• Pharmaceuticals
• Automobile
• Infrastructure

If you diversify by industry, you will minimize your risk, as not all industries will rise and fall simultaneously.

Growth and Value

There is a different growth cycle for each company; recently established companies tend to grow more rapidly than established companies.

Growth Companies have rapidly increasing revenues, profits and cash flow, and their market valuation is higher because of this rapid growth. Value companies have slow growth and are also valued at a low level. The argument goes that value companies outperform growth companies in the long run and vice versa.

Diversification with Mutual Funds

Diversification with mutual funds is relatively easy, since there are many funds that cater to every level of risk and return. Because of this, it is one of the most popular investments, especially among the younger generation. Among the options for diversifying your portfolio are equity, debt, and hybrid funds.

Diversifying across geographies

Globalisation has led to increased investment worldwide. When one geographical region isn’t doing well, diversifying into another area might do better, and you can still make some profit this way.

Personal finance should incorporate diversification as a risk management strategy. Diligent diversification assumes that not every asset class, fund, industry, or sector will peak and fall at the same time, so if you are invested in a diverse portfolio, you are protected when the markets fluctuate. In addition to protecting your portfolio from volatility of the market, diversification will allow you to avoid missing out on significant returns.