Understand how to diversify by investing in stock baskets
If you are a regular investor and work with a professional advisor, you would have often heard about ‘diversification’. That means you should not invest all your money in a single asset class or security type. You should invest your money in a mix of stocks, bonds, money market instruments, real estate, and other relevant avenues.
The concept can appear counterintuitive, especially when the markets are performing well. It is natural to hesitate to allocate some of your funds to assets showing stagnant growth.
While some assets may remain stable, others may increase or decrease in value. By holding a diverse mix of assets, your portfolio becomes more resilient and can better withstand the impact of unfavourable events. So, diversification should be a fundamental component of a long-term investment portfolio.
Here are the benefits that a diversified portfolio offers:
- When you diversify your portfolio, you significantly reduce the impact of poor performance in any single investment. If one asset doesn’t perform well, others can help balance the losses, stabilising your overall returns.
- Diversification can lead to smoother investment returns over time. It mitigates extreme highs and lows that can come with concentrated investments, resulting in a more consistent and less volatile portfolio.
- Diversification isn’t just about increasing returns. It’s also about protecting your capital. Spreading your investments across various assets lowers the risk of losing a significant portion of your investment due to the poor performance of a single asset.
Diversification should also exist within the asset class so your portfolio doesn’t have to undergo heavy losses when the prices of a single security fall. While there are about 2000 companies listed on the National Stock Exchange and another 5000 on the Bombay Stock Exchange, it is not a cakewalk for a retail investor to study every stock and then invest in the ones he thinks will do well.
The simple way to diversify a portfolio is to use stock baskets.
A stock basket is a collection or group of individual stocks traded together as a single unit or investment product. Stocks included in a stock basket are chosen based on a specific theme, strategy, industry, or investment objective.
Stock baskets allow you to enjoy the benefits of diversification without the need for extensive research or managing numerous individual stocks. Here’s how they contribute to reducing your investment risk:
- Stock baskets are built around specific themes or sectors like technology, healthcare, renewable energy, etc. Investing in these baskets allows you to tap into industries with high growth potential while spreading your risk effectively.
- Stock baskets are managed by financial professionals who carefully select and monitor the included stocks. Their expertise ensures that the stocks within the basket align with the chosen theme or strategy, saving you the effort of making individual choices.
- Stock baskets are readily accessible through various investment platforms, making them a hassle-free choice for diversifying your portfolio. You won’t have to deal with the complexities of managing multiple individual stocks.
In a similar context, diversification comes with its own set of risks. In the race to diversify your portfolio, you might end up over-diversifying your portfolio, which may lead to meagre profits, defeating the entire purpose of investing. Excessive diversification happens when an investor’s portfolio becomes overloaded with numerous stocks to the point where the additional reduction in risk doesn’t compensate for the decrease in expected returns.
On the other hand, optimal diversification means that your portfolio is extensive enough to mitigate risks yet small enough to capitalise on the advantages fully.
Imagine you hold 500 stocks from different companies in your portfolio. While this approach lowers risk, it might not yield many high-performing stocks. There could come a time when this portfolio reaches a state of neither profit nor loss.
Stock baskets that invest in more than 100 companies may not yield optimal diversification. It is challenging for the fund manager to achieve ‘alpha’ because of the proportions of stocks held in the portfolio. So, whenever you are investing in stock baskets, ensure they are curated by experts who have a good hold of the research they are doing.
In conclusion, stock baskets are a valuable financial tool that seamlessly fits into the diversification framework. They help you to access diversified portfolios tailored to specific themes or strategies while simplifying your investment journey.
In a constantly evolving financial landscape, embracing the power of diversification through stock baskets can be your key to building a resilient and well-balanced investment portfolio.
Whether you’re an experienced investor or just starting, take a moment to consider the advantages of diversification and explore the opportunities that stock baskets offer for a more secure and prosperous financial future.
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