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Why is Portfolio Diversification Important? How to Diversify Your Portfolio?

Portfolio diversification is the process of investing your wealth in different financial tools. Know why portfolio diversification is important and how you can do it.

  • Apr 27, 2022

One of the best ways of wealth accumulation is investing wisely and staying in sync with the markets. Along with amassing your wealth, this will also help you achieve your long-term financial goals. But the main question is “what should you invest in?”. Honestly, there is no specific or generalized answer for this. However, one investment strategy or, better say, investment principle can help make wise investment decisions: diversification.

Many financial experts believe that diversification is the key to investing, regardless of your financial goal. It may sound complicated, but it is an essential concept that every investor must follow as a principle for investment. It’s simple when it’s about money; you don’t put all your eggs in one basket.

In this article, we will discuss everything about portfolio diversification of portfolio like how to diversify your portfolio, the importance of diversification, why diversification is important, etc.

What is Portfolio Diversification in Investment?

It is the process of spreading your investment around using different financial tools. It ensures that your exposure to one particular financial asset is limited, and you are not highly dependable on any one of them. Diversification is a financial practice designed to reduce the volatility of your portfolio over time.

How to Diversify Your Investment Portfolio?

Now, as we know that the main objective of a portfolio is to reduce by diversification, it can be said that portfolio diversification helps prevent financial damage. So, to understand how to diversify your portfolio, you must follow this 4-step guide.

Step 1: Have multiple investments in your portfolio.

A well-diversified investment portfolio should have multiple investment avenues. So, it is advised to include various investment types in your portfolio and not only rely on one type.

An ideally diversified portfolio should include:

  • Liquidity/cash
  • Bonds
  • Equities
  • Stocks
  • Cash
  • ETFs
  • Mutual Funds
  • Risk assessment like

Step 2: Have various options, even in one individual type.

Suppose you invest in one individual type of investment, say stocks. It is suggested that even if you are investing in stocks, don’t invest in a single stock or few stocks of the same sector; rather, diversify your investment among stocks of different sectors. For example, don’t invest a large amount just in Tech stocks, but rather try diversifying your portfolio into auto, energy, real estate, IT, etc.

Step 3: Invest in options with varying risks.

We know that the main objective of the portfolio is to reduce by diversification, and thus it is advised to invest in options that have varied risks. For example, you must also have a Guaranteed Savings plan in your portfolio if you have invested in the Stock Market.

Step 4: Consider rebalancing important and do it regularly.

You must be thinking by now, why is diversification important? Diversification is important in investing because it helps you in reducing the chances of incurring sudden and heavy losses. So, it is important to maintain the ratio of the amount invested between different investment options so that you stay balanced and grow according to your financial goal.

So, if you are worried about how should I diversify my portfolio, following the steps mentioned above will certainly help you.

Why is Diversification Important in Investing?

It is important to understand your long-term and short-term goals when you are investing. This will help you in understanding how to minimize the losses. And the best way to minimize sudden and huge losses is to diversify. Therefore, it is said that the main objective of the portfolio is to reduce by diversification. The following points explain the importance of diversification:

  • It helps in reducing the stress/dependability on a single investment option.
  • It reduces the chances of incurring a sudden loss.
  • It balances out the overall growth of your investment.
  • It brings uniformity and productivity to your investment.
  • It allows you to invest according to your short-term and long-term goals.

With these and many other benefits of portfolio diversification, you must understand the nuances of the different funds and plans you can invest in and choose the one that makes it most convenient for you to create wealth and secure your financial future.

- A Consumer Education Initiative series by Kotak Life

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