If you are a budding investor, got some spare money and thinking of investing in stock markets and for the first time you walk into broker’s office, tell your broker about your interest. The first thing that broker would be telling is “diversification or portfolio construction”. If you know the word its well and good, but if you don’t have any idea about it then you will be puzzled. You would have read that shares of your favourite company (e.g.: Infosys, Reliance or TCS) are trading well, so you tell your broker that you want to put all your money into stocks of that company. For a moment your stock broker will look at you as if you have fallen from sky, it’s because people living at the stock markets believe that if you don’t diversify then there are very less chances of you surviving in the market. Now, is it always necessary to have a diversified portfolio…..??? If yes then how much should an investor diversify? Are there any side effects of this so called diversification?
Being an investor you must have heard this particular word more than thousand times and I’m also sure that you would have read a lot on this topic, but most of the times the investors do not get the full meaning of portfolio diversification. If you ask what’s diversification most of the answers would be “having shares of many companies” or if he is an investor with bit of knowledge he would say “not putting all your eggs in one basket”. I would agree with the second person to some extent, but if asked to elaborate he will switch over to the first definition, which is incomplete. Diversification does not only refer to holding shares of different companies but holding the securities of many companies, fixed income securities, money market instruments etc, in what proportion we allocate or invest in these avenues depends on our risk taking ability, knowledge to analyse the economic conditions, companies etc.
Advantages of diversifying the Portfolio
Let’s have a look at some of the advantages of diversifying your portfolio
• By diversifying you will be able to hedge (evade) the risk (systematic and unsystematic).
• Even though there are fluctuations in the prices of the stocks in the market, you will have fixed returns.
• Diversification is very helpful for an investor who is looking out for investing in the companies for a long term. The reason is that he will be having a variety of securities in his portfolio and even if one company is going through a lean patch, other securities will be doing well.
• Diversification of portfolio helps during the worst times of the market, when the market has crashed.
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