How Does Portfolio Diversification Help You Reduce Investment Risk?
It is normal to invest in instruments that offer high returns, but it could lead to putting all the eggs in one basket. When an investment is made in high-performing assets, you end up buying at a higher price. When judged on a risk-return basis, the risk is as high as the return. This is where diversification of a portfolio helps. Diversification is the key to maintain risk levels at the lowest and make an effective investment plan. Considering the movement of the market, a diversified portfolio will help distribute financial risks across different instruments and different industries to maintain a balance.
What are the Benefits of diversification?
Following are some of the benefits of portfolio diversification that helps in reducing investment risk:
• Reduces the impact of market volatility
• Reduces the time spent in monitoring the portfolio
• Helps seek advantage of different investment instruments
• Helps achieve long-term investment plans
• Helps avail of benefit of compounding of interest
• Helps keep the capital safe
• Lets you shuffle amongst investments
• Offers peace of mind
Reduces the impact of market volatility
A diversified portfolio minimizes the overall risk associated with the portfolio. Since investment is made across different asset classes and sectors, the overall impact of market volatility comes down. Owning investments across different funds ensures that industry-specific and enterprise-specific risks are low. Thus, it reduces risks and generates higher returns in the long run.
Reduces the time spent in monitoring the portfolio
A diversified portfolio is more stable because not all investments will perform badly at the same time. If you have invested only in equity shares, you will be spending a lot of time studying the market movement and analyzing your next step. Similarly, if you have invested solely into low-risk mutual funds, your all-time worry will be to find avenues to increase returns. With diversification, you will have to spend lesser time on the same and the portfolio will not require a lot of maintenance.
Helps seek advantage of different investment instruments
By selecting mutual funds, investors may gain the benefit of investing in a mix of debt and equity. Similarly, by investing in fixed deposits, investors benefit from a fixed return and a low risk. Hence, diversification of the portfolio will balance the risk and return associated with different funds. Even if one fund does not perform well, the loss may be compensated by the profits made from other funds.
Helps achieve long-term investment plans
It is important for the investor to invest indifferent high-performing sectors. If the market volatility has a positive impact on stocks, the investor will be able to generate higher returns on them. If it has a positive impact on debt, the investor will be able to make the most out of mutual funds.
Helps avail of benefit of compounding of interest
Selecting a mutual fund as an investment option allows investors to avail of the benefit of compounding interest. This means that every investment made will generate interest on the principal amount as well as on the accumulated interest over the previous invested years. It is important to keep in mind that if you are investing in two different funds, the fund holding for both the schemes should be different; otherwise, diversification does not make any sense.
Helps keep the capital safe
Not every investor is ready to play a risky game. Investors who are on the verge of retirement or have just started investing prefer stability in their portfolio and diversification ensures the protection of their savings. Diversification allows investors to achieve their investment plans while maintaining the investment risk at a minimum. It is also a method of playing safe in the volatile market.
Lets you shuffle amongst investments
Diversification is a practical approach that every investor should take advantage of. It allows investors to shuffle their investments and take advantage of the market movement. It lets investors spread their investment across different asset classes and increase annual returns.
Offers peace of mind
The biggest advantage of diversification is peace of mind. When the total investment is divided amongst a number of asset classes, an investor will not be stressed about the performance of the portfolio.
In a nutshell, mutual funds let you allocate your funds not only in different sectors and industries but also in bonds and commodities. This increases the opportunity and the sources of earnings while keeping risks at a minimum.
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