It is because a balanced meal contains all the important nutrients that your body needs and that too in the right quantity. The health of your body is not dependent on only one type of nutrient. It needs different nutrients for their specific benefits and so, you should include protein, fibre, minerals, vitamins, fats, carbohydrates, etc. in your diet.
Now consider applying the same concept to your financial portfolio. Your portfolio needs different types of investment avenues to generate the possible returns. Dependence on only one avenue is not prudent. Just like a healthy body needs multiple nutrients, a healthy financial portfolio needs multiple investment instruments. That is why portfolio diversification is important.
What is portfolio diversification?
Portfolio diversification is an activity wherein you allocate your savings across different types of investments. This allows you to spread the investment risk over different asset classes. Moreover, you can expose your savings to the returns offered by different avenues and maximize risk adjusted returns.
For instance, a portfolio which only invests in equity is highly volatile. If the equity market tumbles, the portfolio will suffer considerable losses. On the other hand, a portfolio which only invests in debt will be alienated from the possibility of high returns that equity may offer. That is why portfolio diversification involves investing in equity and debt along with multiple other options available, in a systematic manner, as per your convenience and risk appetite.
How to diversify your portfolio?
Here are some tips on how you can diversify your investment portfolio –
● Assess your risk appetite
Before you start allocating your savings towards different avenues, you may assess your risk appetite, i.e., your tolerance for undertaking investment risks. If you do not mind risks, you can invest a larger portion of your savings in equity. On the other hand, if you are risk averse, it is better to allocate a larger proportion to debt.
So, first, assess your risk appetite to know which asset class would be a better fit for your portfolio.
● Identify your goals and their horizon
The next thing to do is identify the financial goals for which you want to save and their horizon, i.e., the time period after which you need to fulfil them.
Goal identification will help you choose assets that will align with your needs. For instance, if you are planning to buy a car in the next year or two, you need to pick a short-term investment avenue. Similarly, if you want to plan for your child’s higher education or marriage, you can choose long-term avenues.
● Create an emergency corpus
Once you are done with the preliminary steps, you can start planning your portfolio and its diversification. However, before investing towards your goals, create an emergency corpus. This corpus will help you meet the financial demands of an emergency. Moreover, when you will have an emergency corpus, you can avoid dipping your goal-oriented savings in times of financial crisis. So, you may set aside at least three to six months’1 worth of your income for emergencies. You can consider investing in life Insurance and critical illness plans/riders for financial assistance to you and your family in the case of premature death or medical contingencies.
● Invest in different types of securities
Now is the time to diversify your portfolio. To do so, explore the different types of investment avenues available in the market. You can consider investing in market linked plans like ULIPs.–
Explore these avenues and invest in those that match yours –
Allocate your savings across different avenues so that you can enjoy better returns while the risks are diversified.
● Opt for readymade diversified portfolios
Rather than choosing individual investment avenues, you can also opt for readymade diversified portfolios like those offered by ULIPs, etc. These schemes have a readymade portfolio which is diversified across different securities and also professionally managed. For instance, under ULIPs, you can invest in equity, debt and balanced funds and each fund has a diversified basket of market linked securities.
● Plan taxes too
While diversifying your portfolio, take care to plan your taxes too. There are different types of investment avenues that provide tax benefits either at the of investing or on the returns earned. Life insurance plans are one such example.
The bottom line
Pick from different investment avenues for a diversified and balanced portfolio that allows equity-oriented returns as well as debt-oriented stability. Make a healthy portfolio which helps you achieve your goals without any hassles and makes you financially independent.
References
https://cleartax.in/s/emergency-fund-invest
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