Aug 2022
5 mins read

7 Effective Tips for Portfolio Diversification

Don’t put all your eggs in one basket, says an old adage. The more options you give yourself, the more you can mitigate the risk of non-achievement by spreading out the risk. Diversification is the process of spreading your investments across different assets, to optimise your chances of strong returns and to mitigate investment risk in your investment portfolio. But how do you go about diversifying your portfolio? Here are seven ways to do it:

Assess your risk profile and investment needs

Before you set out to diversify your investments, carefully review your risk tolerance, financial goals and investment horizon. These three factors will help you identify suitable assets for investment (you can use investment calculators to determine them). Consult a professional financial advisor to help you assess these factors. 

point 1

Optimise your asset allocation

Asset allocation means choosing and investing in different asset classes like equity, debt, real estate, gold etc. This is at the core of diversification. Divide your funds and invest them in different types of asset classes for a diversified portfolio. Your asset allocation would largely depend on your financial goals and risk appetite.

point 2

Diversify within asset classes

You can diversify even within the same asset class. For instance, in equity, you could invest across sectors and market capitalisations just like multi-cap funds or flexi-cap funds. Similarly, you may invest across fixed deposits, PPF, recurring deposits, debt funds etc. for a well-spread debt allocation.

point 3

Invest internationally

Investing in the international market allows you to diversify across geographies, in order to benefit from the growth in global economies.. You can explore international stocks, ETFs or mutual funds to spread your investments globally.

point 4

Plan your taxes

When diversifying, consider the tax implications of your investments too. Choose avenues that give you tax benefits on investments as well as on the returns. ELSS, NPS and 5-year FDs are examples of investments with tax benefits.

point 5

Create an emergency fund

As the pandemic has shown us, an emergency fund is invaluable in weathering a crisis, like a job loss. Emergency funds can help you stay afloat for a few months without draining your savings. Ideally, set aside 6-12 months1 of your income in an emergency fund and invest it in a liquid asset so that it can be redeemed whenever needed.

point 6

Rebalance and review

Diversification is not a one-time task. Keep reviewing your portfolio regularly to ensure it remains well diversified and aligned with your changing goals and risk appetite.

point 7
Diversification gives you room to manoeuvre as the market changes. It optimises the return potential of your portfolio while hedging your risks. A balanced, diversified portfolio is the key to achieving your financial goals through investments.
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