To thereby lower risk and enhance returns, you diversify your investment holdings. Such diversification: involves more than one class of assets – stocks, bonds and cash investments – invested in diverse asset classes: containing stocks in many different proportions of large-capitalisation, mid-capitalisation, small-capitalisation, aggressive growth or value orientation … or bonds that are of long-, intermediate- or short-term maturity or of investment-grade, non-investment-grade or fixed-rate or floating-rate securities … or comprised of multiple funds in distinct sectors or involving multiple countries or investing in multiple styles or with varying investment objectives;and selection of which assets should complement the others requires thoughtful, as opposed to haphazard, analysis.
Sectors
By spreading money across different investments, and often across different sectors of the market, you can minimise the risk of large losses. The idea is to make sure that the various components of your portfolio rise and fall in response to economic developments in different ways; this way they won’t tend to move in lockstep.
Sector investing gets you exposure to different parts of the economy, such as energy or technology. Sector funds or ETFs can be used as a low-cost way to diversify your portfolio.
Ideally, add real estate, international securities and cash (or cash equivalents) to your portfolio mix to expand its overall spacing. Each of these investment types offers something unique: for example, real estate offers low correlation with stocks, while a portion of your investment serves as a hedge against the loss in buying power that comes from inflation; foreign securities offer growth opportunities not available here at home.
Liquid Funds
Taking that step requires some thought about your investment objectives, time horizon and liquidity needs. Only once these are defined should you start researching funds – finding those that match your financial goals and risk appetite, and comparing them with regard to performance and risk vs return potential, fund size and expertise/track record of their manager.
Diversification can reduce risk and generate stronger returns in the long run. Putting 100 per cent of your stock portfolio into, say, Apple would be extraordinarily risky. If technology collapsed as a sector, then so does your whole portfolio. That’s risky. Therefore, one should consider diversification of the portfolio with stocks, bonds and REITs. And taking some considerations of diversification alongside the asset classes – as well as foreign assets – can minimise risks, too.
Debt Funds
Investment in debt funds can help de-risk your portfolio and improve returns, but investors need to take extra care in choosing the right bird from the right cage. An important point to note is that you have to pick a class of fixed-income fund which matches both your goal horizon and investment horizon. If the volume of money is NRs 50 lakh and the goal is to achieve the goals within a year, liquid/ultra-short funds will serve your purpose. Long-term goals, such as goals completed 10 years down the road, will see better opportunities in dynamic bond funds.
Understand the associated risks, such as interest rate risk, credit risk and prepayment risk, that come with debt funds so as to be knowledgeable about all the details and vary portfolio composition accordingly. Look at past performances and what’s happening around the current market for a view on the future performances, so you might not be surprised by any significant market swings while enjoying the highest net returns.
Equity Funds
Finally, add equity funds to the mix. Again, sector funds offer the greatest betas since they are most tied to each area of the economy. They also offer the most distinguishing from the betas you get in large-cap stocks.
A diversified portfolio should contain bonds, as well as real estate, foreign securities and cash. Each of them provide disparate benefits – inflation protection, low ‘correlation’ with stocks (so they rise when stocks drop), and so on.
Review your financial goals, risk tolerance and time horizon to determine how much, in terms of each stock variant, you should have in your portfolio now. After that, construct a diversified portfolio to take you to the point of financial independence and, finally, rebalance it regularly to keep it on track towards the point and with your risk tolerance intact.
