In the world of share investments, no two opinions exist that diversification is a concept that finds acceptance from majority of the investors. Acknowledging this principle, most of the portfolios created by the investors or by brokers for the benefit of their clients have 10-12 shares. With a diversified portfolio, risk stands reduced, as the share values happen to rise or fall and there is no relation between the two shares of the same portfolio for variation in prices. Overall risk, therefore, stands reduced, if not eliminated totally.
Why diversification is absolutely necessary?
The final goal in diversification is to improve performance, secure more profits, and manage the risks that are inseparable part of the share market. There are two types of risks, unsystematic risk and systematic risk. The former relates to a specific company. Unexpected issues can crop up in a particular company, such as a strike, natural calamities like fire or earthquake, and abrupt slump in the sales due to competitive technological innovations etc. A diversified portfolio is an insurance against such happenings, as all these cannot happen simultaneously in all the companies forming part of the portfolio.
The issues that affect the entire economy belong to the latter category. Some of them are fluctuation in interest rates, wars and inflation. The diversified portfolio has no solution for such risks. Experts and the researchers look at diversification from the angle of volatility of shares. Anything from 10-30 shares forms an ideal portfolio. In this age of internet evolution, many investors think in global terms. Investments done outside the country carry the additional risks like political uncertainty, currency inflation etc.
One issue is clear. The best of the stock investment diversification is no guarantee to enhance returns. It may fail to outperform a non-diversified portfolio. It does not ensure against market risks. So also, past performance of companies is no guarantee for the future results. In the fast-changing technological scene and intense competition in the export/import trade, many companies had to pull down the shutters.
Yet, diversification is one of the best solutions to tackle risks in the share market. The experts on this subject provide some tips. One or more of them may hold well at a particular time and save your portfolio from suffering losses.
Investment diversification depends upon your goals. The time that you have to reach the goal and the capacity to invest regularly is the relevant factor. What is your expectation of the growth of your assets? Are you willing to take any risks and if so the level up to which you will do so? The same investor may have multiple goals. One at the time of his marriage, and one at the age of 50 when the children seek admission in costly professional colleges! If you are a retired person, protecting the principle amount is your major goal and securing the maximum returns is the secondary goal. At that stage you are not willing to take any risks at all.
Growth and income are like two arms of the scale and they need to balance properly. A harmonious blending of growth investments with those which produce income is ideal.
Let large and small companies form part of your portfolio. Let new companies find place along with the well established ones.
Take care of different segments; invest in unrelated industries and look out for the mix of government and corporate investments. Invest internationally in companies based in different countries. Examine the balance sheet of some of the sluggish companies at present, but have the potential to turn the corner and produce better results in the not too distant future.
Stock brokers, financial consultants can assist you in finalizing your diversification proposal when you explain to them your financial needs and objectives. You can also do it yourself, but taking advice from the brokers who have wide experience in dealing with market conditions, is better. The gains that are likely to accrue will certainly outweigh the brokerage that you will pay. Two heads are better than one in taking important investment decisions.
For more details you can consult with CL King & Associates.
CL King provides investment banking, equity research, sales and trading, and investor services to corporations and institutions. We co-manage bond offerings, IPOs, follow-ons, secondaries, convertibles, and preferred.
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