Why Portfolio Diversification Matters

Portfolio diversification simply means investing your money in different asset classes. By enabling you to invest in a variety of assets, rather than just one or two, it allows you to balance risk better and optimise returns.
Sep 2022
3 mins read

Recap – the different types of asset classes

There are many types of asset classes, and each of them comes with their own risk profile and returns potential. Let's look at some of the most popular asset classes for investors.

Asset ClassExamplesReturn PotentialRisk Profile
Cash and Cash EquivalentsMoney Market Instruments
Savings Accounts
Cash in Hand

LowVery Low

Equity Mutual Funds

Moderately High to HighModerate to High
Debt Mutual Funds
Government Securities
Low to ModerateModerately Low to Moderate
Real EstateCommercial Properties
Residential Properties
Moderate to HighModerate to High
Moderate to HighModerately High to High

 US Dollar, other currencies

Low to ModerateVery High
AlternativesArt, Painting, Crypto CurrencyHighVery High
Why should you diversify your assets?

1. To pick the advantages of each asset class and negate its downsides
The primary benefit of diversification is getting exposure to different types of investment avenues and maximizing their benefits while minimising the negatives. Each avenue, of course, has its own features and benefits.

Asset ClassProsCons
Cash and Cash EquivalentsHighly liquidMinimal returns
EquityTax benefits if held for 12 months or more; can be inflation-beatingProne to short-term volatility 
DebtAdds stability to the portfolio and offers good liquidityLower comparative Return potential than Equities over long term
Real EstateHelps in asset creation apart from carrying good return potentialNot very liquid, High transaction cost
CommoditiesOften carries a negative correlation to equity and is a hedge against adverse geopolitical eventsHighly volatile, Demand-Supply scenarios are very dynamic
AlternativesDiversification benefit, due to low correlation with main stream investments Liquidity issue

CurrencyPossible contributor to returns in cross geography investmentExposed to country specific risk and macros
Depending on your investment style, you may want to add two or more of these assets to your portfolio and enjoy the respective benefits of some while hedging against the disadvantage of others.

2. To mitigate investment risks
Different assets have different risk profiles, as seen above. For instance, equity is prone to high short-term volatility, while debt may not be as volatile. Since all asset classes may not always move in the same direction, you can balance out the investment risk in your portfolio – the gain from one asset can offset the loss from another.

3. To match your investments to your goals
Different goals might need different assets or a mix of them. For instance, if you are saving for a trip next year, you will need a liquid asset that can be redeemed quickly when needed. But if you are investing for your retirement, you may need a long-term option that can help you potentially generate inflation-beating returns, such as equity. However, you would also need the stability provided by debt instruments.

While diversification is good, you can have too much of a good thing – beware of over-diversification, which can hamper your portfolio. If your disposable income is limited and you invest in too many assets, the effective investment in each asset gets limited, and you might not enjoy the full benefit of that asset. Besides, managing an over-diversified portfolio is also tough. So, just remember to use diversification wisely and in moderation, and your portfolio will reap the rewards.


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