Diversification means spreading out your money into different types of investments to reduce risk while still allowing your money to grow. It’s one of the most basic principle of Investing.
When we talk about diversification, we often recommend having various types of investments (called asset classes) in your portfolio. Here are the most common asset classes:
- Mutual funds Single stocks Bonds
- Exchange-traded funds (ETFs) Index funds
- Real estate
Asset Allocation
Asset allocation involves dividing an investment portfolio among different asset categories, such as stocks, bonds, and cash. The asset allocation that works best for you at any given point in your life will depend largely on your time horizon and your ability to tolerate risk.
Time Horizon
Your time horizon is the expected number of months, years, or decades you will be investing to achieve a particular financial goal. An investor with a longer time horizon may feel more comfortable taking on a riskier, or more volatile, investment because he or she can wait out slow economic cycles and the inevitable ups and downs of our markets
Risk Tolerance
Risk tolerance is your ability and willingness to lose some or all of your original investment in exchange for greater potential returns. An aggressive investor, or one with a high-risk tolerance, is more likely to risk losing money in order to get better results. A conservative investor, or one with a low-risk tolerance, tends to favor investments that will preserve his or her original investment. In the words of the famous saying, conservative investors keep a “bird in the hand,” while aggressive investors seek “two in the bush.”
Conclusion
By picking the right group of investments, you may be able to limit your losses and reduce the fluctuations of investment returns without sacrificing too much potential gain.
It is the tendency of Indians to allocate most of their wealth in physical assets such as gold and real estate. But it is evident that the financial assets such as stocks has outclassed physical asset in the long run. And that’s why our financial experts suggest to diversify your portfolio according to your long term and short term goals.
