Diversification is a very commonly used word in the investment arena. It stands for how you allocate your resources amongst different asset classes and between the asset class in itself. Diversification is necessary to mitigate risk to a certain extent. However, there are numerous myths about diversification amongst investors. So, in this article, we will discuss such four myths which can ruin your portfolio diversification if you don’t find out the reality.
#Myth 1: You can only diversify with equities and debt instruments
While there are multiple asset classes to invest in, people only invest more in equities and debt products. Other asset classes are sometimes even overlooked!
For example, Gold is often considered to be jewellery and not an asset class for investment. However, it is a highly beneficial investment, especially in times of crisis. Recently, in the year 2020, when the entire economy was in turmoil due to covid-19, gold prices rose to around INR 57000 for 10gms of 24k gold (99.9% purity) in Aug 2020. So, you can induce gold in your portfolio to mitigate the risk and diversify your portfolio.
Diversification is not about one asset class; instead, it is about how well you incorporate different asset classes in your portfolio that are not co-related. Gold and equity market share an inverse co-relation. So, a little gold in your portfolio would do good, especially if the markets behave unexpectedly!
#Myth 2: Over-diversification is healthy for an investment portfolio.
One recent study has found that people are comfortable investing in equity and other asset classes they are aware of. Maybe it is because the known products are easy to monitor, and the investors have faith in them.
But, on the other hand, over-diversification could be detrimental to an investment portfolio. This is because if one or two asset class or companies actually perform well, then the exposure in that asset class would be so insignificant as compared to the overall portfolio; that the returns would hardly make a difference in the overall portfolio’s return on investmnet. Also, if one industry performs poorly, which affects another, investing in both sectors would not be considered diversification.
So, just like a balanced diet is essential for a healthy body, the right mix of assets in your investment portfolio according to the ideal asset allocation is essential. So, it hardly matters how many investment products you have, over-eating of a single food isn’t healthy. You need to have an investment in asset classes that are in tandem with your financial goals without over diversifying in any.
Additional Read: Benefit of Asset Allocation in the Portfolio
#Myth 3: Diversification protects you from losses
Diversification helps mitigate the overall risk of the investment portfolio by spreading it across various asset classes, but it doesn’t guarantee that you won’t incur any loss. You need to understand that whether you invest in equity funds, debt funds, gold, or any other funds, you can incur losses if the market becomes bearish. However, with proper diversification and asset allocation, the losses can be minimised.
#Myth 4: investing in Alternative Asset Class and International Funds is risky
Often people believe that alternative investments are risky. However, to diversify your portfolio, alternative investments in, say, REIT (Real Estate Investment Trust) funds can do wonders. It can reduce the risk as real estate is negatively correlated to the equity and the debt market.
Another excellent financial instrument for diversification is international funds. There has been a recent episode of Rupee Depreciation to a nine-month low of only INR 75.4 against USD in April 2021, which led to one of the biggest losers amongst the currencies of the emerging markets. So, to hedge against the rupee-dollar fluctuations, you can invest international funds. This category has gained attention in the last couple of years because of growth in assets and return on investment.
Additional Read: Investing in International Funds for Portfolio Diversification
Diversification is necessary, but you need to diversify being aware of the myths. Investors often fall for these myths and diversify in the wrong way, which leads to losses. You should diversify in different asset classes – equities, debt, gold, REITs, International funds, and others. One of the best ways to diversify your portfolio is using mutual funds as they already have well-diversified portfolios and experienced fund managers manage the same. You can also get in touch with Tata Capital Wealth’s experienced relationship managers to help you choose the funds as per your risk appetite and investment goals.