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
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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 Class | Examples | Return Potential | Risk Profile |
| Cash and Cash Equivalents | Money Market Instruments
Savings Accounts Cash in Hand | Low | Very Low |
| Equity | Stocks
| Moderately High to High | Moderate to High |
| Debt | Bonds
Debt Mutual Funds Government Securities | Low to Moderate | Moderately Low to Moderate |
| Real Estate | Commercial Properties
Residential Properties REIT | Moderate to High | Moderate to High |
| Commodities | Gold
Silver Metals | Moderate to High | Moderately High to High |
| Currency | US Dollar, other currencies | Low to Moderate | Very High |
| Alternatives | Art, Painting, Crypto Currency | High | Very 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 Class | Pros | Cons |
| Cash and Cash Equivalents | Highly liquid | Minimal returns |
| Equity | Tax benefits if held for 12 months or more; can be inflation-beating | Prone to short-term volatility |
| Debt | Adds stability to the portfolio and offers good liquidity | Lower comparative Return potential than Equities over long term |
| Real Estate | Helps in asset creation apart from carrying good return potential | Not very liquid, High transaction cost |
| Commodities | Often carries a negative correlation to equity and is a hedge against adverse geopolitical events | Highly volatile, Demand-Supply scenarios are very dynamic |
| Alternatives | Diversification benefit, due to low correlation with main stream investments | Liquidity issue
|
| Currency | Possible contributor to returns in cross geography investment | Exposed 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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PGIM India Asset Management Private Limited
(CIN - U74900MH2008FTC187029)
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Email: care@pgimindia.co.in
This is an Investor Education and Awareness Initiative by PGIM India Mutual Fund.
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MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY. Read more
All the Mutual Fund investors have to go through a one-time KYC (Know Your Customers) process. Investor should deal only with the Registered Mutual Funds (RMF). For more info on KYC, RMF and procedure to lodge/redress any complaints, visit https://www.pgimindiamf.com/ieid.
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY. Read more
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