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Why is it necessary to have a diversified share market portfolio?

If you’re an investor, you must have definitely heard one piece of advice: have a diversified portfolio. But what exactly does this mean? And as an investor in the stock market, what does it mean for you to have a diversified portfolio?

What is a diversified portfolio?

To put it simply, diversification means not putting all eggs in one basket. Translated in terms of the stock market, this means spreading investments across different assets to minimize the risk.

A diversified portfolio has its investments spread across a range of assets:

  • Equities
  • Mutual Funds
  • Listed debt instruments
  • Both Gold ETFs and physical gold
  • Insurance

Even within asset classes, a diversified portfolio does not expose itself in one particular sector. For example, consider equities. It is not beneficial for an investor to allocate a large amount of funds into risky small cap or mid cap stocks. Maintaining a balance intra-class is also equally important. Along with the type of stocks (large, mid and small cap), it is essential to not have overexposure to a particular sector, like metals or pharmaceuticals, or banking.

The reason for limiting exposure in each asset class is so that underperformance in one sector does not pull down the results for the whole portfolio. For example, in the current market scenario, equities are underperforming as compared to 2017. By diversifying into debt instruments, or mutual funds, or other non-listed fixed income instruments, the overall risk of the portfolio is reduced. Underperformance in one part of the portfolio is compensated by a decent growth in another part of the portfolio. Getting such insights becomes easier if you have a demat account with an industry frontrunner depository participant, such as Kotak Securities. 

How to have a diversified portfolio?

There is no set strategy for a diversified portfolio. There is no rule of thumb to be followed for investing in different asset classes. The starting point, however, depends on the risk appetite of the investor. If you’re an aggressive investor, who can afford to take risks, then you can accordingly invest a larger percentage of your portfolio in equities and a lesser portion in debt and fixed income instruments. If you are an investor looking for immediate liquidity at hand, it makes sense to allocate majority of your resources in debt instruments.

One way to collectively reduce the risk on your portfolio and also meet earning goals is to invest in mutual funds. Mutual funds are an excellent investment for investors who want to grow their capital without the risks associated with directly investing in equities. Mutual funds are also a perfect asset class for those who do not have the expertise to invest in equities.

Typically, a diversified mutual fund portfolio can have a greater chance of improving your wealth and growing your capital. SEBI’s revised guidelines on mutual fund classification have made it easier for investors, especially first time investors to find the right mutual fund for them to invest in. For those investors looking to make stable returns, there are a variety of debt mutual funds that invest in a range of debt instruments based on the duration. For investors looking to enter the equity market, they can consider investing in a multi cap or a large cap fund that provides safe returns even in choppy markets. Aggressive and risky investors can invest in mid cap or small cap funds. Investors looking to save tax can invest in ELSS funds that provide tax breaks.

Having a diversified mutual fund portfolio takes a thorough knowledge of your investment goals for the short, medium and long term horizon. You can open a demat account with the brokerage firms such as Kotak Securities and start your mutual fund investments right away.

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