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Diversified Portfolios

What are Diversified Portfolios

Here we will discuss how to build a diversified portfolio and that too a strong portfolio and also try to understand that what is the need and reason behind it to build a strong portfolio. If you just cannot understand a lot about the terms and terminologies related to the investments and the finance in particular, how so ever it does not matter much if you are mentally prepared to understand them.
1)   What is a portfolio: - In simple word the portfolio is nothing but all your investments put together is your portfolio, as simple as that. So suppose that you have 2, 50,000 in shares, 50, 00000 in real estate and 5, 00000 in cash, than this is your portfolio.
2)    What is an asset class: - An asset class is simply something where we can invest and build assets.  Suppose if you buy a house, flat or a land than you are building an asset in the asset category and on the other hand if you are buying in the shares or the mutual funds/ equity than you are creating assets in the equity asset class.
Following are some of the asset classes:-
1)   Equity: - Shares, equity, mutual funds and the derivatives (F&O).
2)   Debt: - FDs, PPFs, NSCs, FMPs (how to find the best FDs).
3)   Real Estate: -Flat, house, land for residential or commercial proper ties.
4)   Commodities.
5)   Gold or Silver.
6)   Cash.

3)   What is the diversified portfolio: - The diversified portfolio is simply a portfolio which is not heavily invested in some of the asset class. Then there is a basic thumb rule that what % of your portfolio shall go in which asset class entirely depends upon- a) Your risk taking appetite, b) Goals which may be short, middle or the long term. c) Economical and political atmosphere. d) Current market over the long term.

4)   What is the need for the diversification: - See when you diversify your investments over the various asset classes not only your money gets diversified but so also the impact of the risk what so ever gets diversified too. So just in case if some particular asset class is not performing well enough then it effect that part of your portfolio and not the overall assets of yours. It is but obvious that it also affects the returns as your returns are the collection of the returns from all the asset classes. So what even if some of the asset classes did not perform over a period, it doesn’t affects you that badly after all.

Every asset class provides certain things like:-
a)    Equity: - Very high returns, volatility as well as the liquidity.
b)   Debt: -Low but secure returns but no liquidity.
c)    Real Estate: - Good returns, stability but no liquidity.
d)   Gold: -Hedge against the inflation and stability.
e)    Cash: - High liquidity.

So every asset class provides something good and bad in the platter. However the diversification only helps in getting all the benefits in some or the other way as the crux- with the diversification of your portfolio you will get the best of all the world like the good returns, stable returns, liquidity as well as the security. Let’s go by the example when the people did not diversify:-

a)      Anybody who was heavily invested in the debt around the early 2004, just didn’t get the high returns from the zooming stock markets (equity) for atleast 4 to 5 years and on the contrary in the similar situation around the beginning of the 2008the investors witnessed his investments skid down by 40 to 60% overall.

b)      If someone who is totally invested in the debt he just cannot get instant money if required due to the lack of the liquidity and if the need be than either he has to take loan over those investments or do away with his FFs or the FDs etc. So it does not always implies that the non diversification always gets hit badly, as anyone who had heavily invested in the equities before the ball run in the year 2003 onwards made fortunes but it was at their own risk. Secondly those who had invested then in the gold in the year 2007 got the highest returns as compared to any other asset class.

However it all depends totally from the person to person. So this point is of the utmost importance and should be very crystal clear that inside every asset class another lever of the diversification is equally important. Like in the equity there are large, mid and small caps as well.

5)   The precautions to be taken while restructuring the portfolio are:-

a)    The exposure to the asset class should be very well balanced keeping in mind the long term overview and not to get carried away by the scenario of the present.
b)   Moreover the life insurance should always be such so that one is more than sufficiently covered.
c)    The equity and the debt ought to be very well balanced.
d)   One must also be extra cautious while investing in the real estate that the investments must be at those locations where the value of the land appreciates better as per your expected time frame.
e)    The liquidity factor must also be kept in mind so that the need to break the FDs does not arise.

So to sum it up the diversification in simple words does not means that you have to invest some money in every asset class for sure. The main principle of diversification is that the risk is minimized by the diversification and the portfolio becomes much more stable.