Benjamin Graham once said – “Diversification is the companion of margin of safety”.In simpler words diversification of portfolio and safety of returns go hand in hand, As diversification increases so does the safety of our investments, if done in a planned way.
Lets first know why should one diversify and what it actually means
Diversification means spreading/investing your money across different assets to reduce your loss. It is one of the most effective and least expensive ways to reduce one’s risks without sacrificing hugely on returns. Infact, it may even help in maximising returns.
It can be understood by the real life example of when you are told to not put too many apples in one bag , instead to use another one so the first one doesn’t split open. This way you spread the weight of your apples in different bags to ensure that none of them tears and even if one bag does, the apples in the 2nd bag still remain safe. Assume those apples to be your money invested in different bags or assets.
Coming to the part where you want to know the benefits of diversification, one thing gets clear that it reduces risk of loss but it doesn’t end here.
It helps in generating returns as sometimes a concentrated investment doesn’t perform well but by diversifying you are not dependent upon that one particular source of income only. For the people who are close to retirement and have preservation of capital as their main goal, diversification helps them by protecting their savings and channelising them into the most productive way and also for the ones who are making unsure investments.
*unsure investments are those in which people are not sure about the future performance of their investments and are done without proper research (although one will always be at higher degrees of risk without full facts and knowledge of such investments).
Now the question comes, how can one diversify?
- one can diversify by investing in what is known as five basic asset classes – stocks, bond, cash, real estate and commodities like gold
- within asset classes such as purchasing shares across different industry sectors
- across different funds, if investing in funds
It is important to see that one does not put all their money in one stock or a sector, no matter how good the returns are as the risk is always greater that way. If you are sure, have a good amount of knowledge and know about the market then yes you can go for it, just remember no one saw covid19 coming. What you can do is create your own virtual mutual fund by investing in a handful of companies you know and are aware about. These could also be the companies whose product you use on a daily basis. Knowing a company and its financials can be a healthy and beneficial approach towards investing.
Yess, it’s that simple!! You just need to spread your investments and have a diversified portfolio. Using mutual funds to diversify in these classes is also a good approach. While explaining diversification to one of my friends, he said what if i diversify on a large scale,what if i don’t concentrate at all?
“It may be unwise to spread one’s funds over too many different securities,” said Bernard Baruch. “Time and energy are required to keep abreast of the forces that may change the value of a security. While one can know all there is to know about a few issues, one cannot possibly know all one needs to know about a great many issues.”
Think – do you have the time to keep insights about lots of companies in your portfolio? The average person simply cannot pay good attention to the one stock he has bought, that’s why he diversifies it.
Now this might confuse you as to whether to diversify or not. It’s a tricky game . you need to find which option suits you better-
You can invest in one asset but you need to watch that “BAG” carefully or if you want to invest by not being too INVOLVED and are unsure about the future performance of your investment, you know the word –diversify. Just be sure to have a pinch of knowledge about your investments😉