Why is Portfolio Diversification Important?

Diversification is the practice of spreading your investments across various assets to limit your exposure to any single type of asset. Its purpose is to decrease the volatility of your investment portfolio over time. The key factor in achieving this is correlation. By balancing the risk of one type of asset against another, correlation measures the extent to which two securities move in the same direction. A well-diversified portfolio, therefore, consists of groups of assets that are lowly or negatively correlated with each other. For example, an investor holding a portfolio of 20 technology stocks lacks diversification. On the other hand, an investor with a 20-stock portfolio covering a range of industries, bonds, and real estate, achieves a decent level of diversification.
 

Asset Classes

A portfolio can be diversified across asset classes, sectors as well as geographically by investing in domestic and foreign markets. An asset class is a grouping of investments based on shared behaviors, characteristics, and regulations. The different asset classes are:

Stocks – publicly traded company equity or shares
Bonds – government or corporate fixed-income securities
Real Estate – buildings, land, livestock, agriculture, water, mineral deposits.
Exchange Traded Funds – a basket of securities that follow an index, commodity, or sector. It is listed on the stock exchange.
Commodities – materials that are required for manufacturing other products /services.
Cash or Cash Equivalents – savings account, certificate of deposit, treasury bills, money market instruments, and other short-term, low-risk investments.

How to diversify your portfolio?

There are many benefits of diversification. However, it must be done with caution. Here’s how you can effectively diversify your portfolio:

1. Spread out your investments

Investing in equities is good but that doesn’t mean you should put all your wealth in a single stock or a single sector. The same principle applies to other investment options such as fixed deposits, mutual funds, or gold. Even if you choose to invest in the same asset, you can still achieve diversification by investing across various sectors and industries. There are so many different industries and sectors to explore, each offering tempting opportunities, such as pharmaceuticals, information technology (IT), consumer goods, mining, aviation, energy, and many more.

2. Explore other investment avenues

You could also add other investment options and assets to your portfolio. Mutual funds, bonds, real estate and pension plans are other investments you can consider. Also, make sure that the securities vary in risk and follow different market trends. A common observation is that the bond and equity markets often move in opposite directions. By investing in both, you can mitigate potential negative outcomes in one market by taking advantage of positive movements in the other. This approach helps you avoid being caught in a lose-lose situation.

3. Consider Index or bond funds

A sound diversification strategy, adding Index or bond funds to the mix provides your portfolio with much-needed stability. Also, investing in Index funds is highly cost-effective as the charges are quite low compared to actively managed funds. At the same time, investing in bond funds hedges your portfolio from market volatility and uncertainty and prevents gains from being wiped out during market volatility.

4. Know when to get out

Part of portfolio diversification is knowing when to exit your investments. If the asset class you're invested in has underperformed over a long period of time, and if there have been changes in its fundamental structure that don't match your goals and risk appetite, then you need to get out. Also, if you've invested in a market-linked instrument, don't get out because of short-term volatility.

Benefits of Portfolio Diversification

Portfolio diversification protects you from different investment risks while securing your future and fighting inflation. By spreading your investments across different sectors, you protect yourself from the volatility of any one sector. In addition, relying solely on equities for investment returns can be risky due to the historical volatility of the market. Similarly, safe investments such as fixed deposits offer low returns. However, by diversifying your investments across different asset classes, you can achieve higher and more consistent overall returns.
Another benefit of diversifying your portfolio is improved liquidity. While safe options such as fixed deposits or public provident funds may have lock-in periods, diversifying your portfolio allows you to invest in liquid assets alongside these safe investments. This flexibility allows you to access cash quickly in an emergency without incurring fines or penalties.

Why consider Scramble to diversify your portfolio?

-Scramble offers the opportunity to invest in business loans, allowing you to allocate funds to a different asset class that can potentially generate attractive returns.

-Investing through Scramble allows you to add geographic diversification to your portfolio. Currently, we work with consumer goods brands from the UK, offering exposure to a specific market and potentially reducing the impact of regional economic fluctuations on your overall portfolio.

-Scramble gives you the flexibility to adjust your risk exposure based on your preferences. You can choose to invest in either senior or junior loans, allowing you to tailor your investment strategy to suit your risk tolerance and investment goals. You can read more about the loan groups here.

-With Scramble, you diversify your risk from the outset. Instead of lending to a single company, investors lend to a batch of companies. Even if one borrower fails to repay the loan, the other companies in the batch continue to meet their obligations, reducing the overall impact on your investment.

Regardless of your goal, time horizon, or risk tolerance, a diversified portfolio is the foundation of any smart investment strategy.