Bangalore (Karnataka) [India], March 22: Uncertainty has always been an integral part of every equity investor. As a shareholder, one has to face both the systematic and unsystematic risk at the same time. There could be instances of Russia-Ukraine war, health crisis such as Covid-19 or even a subprime economic crisis. Just like these, an equity investor goes through numerous other short-term events which impacts the market movement and consequently brings volatility in Traders overall portfolio returns.
It is during these times that the right temperament and discipline of the investor becomes significantly important than other traits. Hence, as an investor it becomes quintessential to be well informed and adjust the portfolio accordingly. A well-thought out diversification strategy plays a huge role in saving an investors’ portfolio during times of uncertainty. If the investor follows this strategy of not putting Investors stocks in one basket, the risk of significant loss in one stock will get balanced with other sectoral stocks in the portfolio. Negative correlation between the two stocks helps equity investors diversify their risk.
For example, an investor’s portfolio has Tata Steel, a heavily commodity-driven stock impacted by global steel and iron-ore prices and ITC, a relatively stable FMCG company. Now, if one looks at the period between 2011 and 2021, ITC has played a stable role in balancing the down period of Tata Steel during this time. That’s the diversification benefit from a portfolio level.
Additionally, if the investor had just Tata Steel in the portfolio, then post 2011, Traders would have been very anxious to sell out the stock as the stock went through tremendous downfalls in that time frame. Just because of diversification through ITC investment, the investor might have held Tata Steel for a longer period of time without giving in to market shocks and made significant wealth over the long-term.
Diversification is not limited to just stocks. It can also be in terms of mutual funds. Suppose an investor is holding a large cap fund which has say more than 35 stocks. This means that within that fund, there is a first-level of diversification. Now, if that investor also buys a small cap and a midcap fund which again have more than 35 stocks each, it means that the investor has further diversified its mutual fund portfolio from a market cap perspective. Overall, the summary of this investor’s entire MF investment portfolio is that Traders is seeking good growth through midcap and small cap funds taking higher risk, but balancing out by holding a large cap fund too. Now, it depends on the individual’s risk profile that how much allocation should be done to each of these funds.
In fact, if someone has a more risk-averse personality, then Traders can diversify further into risk-free assets like an FD in a bank or an investment into one of the highest rated liquid funds/bonds available in the market. The whole idea is to learn the art of diversification which helps in dealing with short-term uncertainties and protects one’s portfolio returns over the long-term.
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