3 Ways of Diversifying across stocks
3 Ways of Diversifying across stocks
Diversification- in terms of investing- is the practice of spreading your investments around so that your exposure to a singular stock is limited in your portfolio. This is one of the epitome measures to be taken to reduce the volatility side of any portfolio.
Diversification is a broadly used term as such. One can consider diversification in investment in line with multiple asset classes, into different companies, countries and also into different industries. This reduces the probability of an investment having a significant impact on your returns if one of the outcomes turn out to be unexpected. Despite diversification being such a simplified investment concept, many investors do not consider it important and instead lose their money by falling in love with just a handful of investments.
One of the prime and widely used methods of diversification in the asset class of stocks, is to invest in index funds (a portfolio of stocks designed to mimic the composition and performance of a financial market index), in India the index funds are Nifty (that comprises of 50 companies) and the Sensex (that comprises of 30 companies). These indexes are also the measure for growth and comparability for active investor’s portfolios to beat (referring to the phrase “outperforming the market).
If you are planning to invest in individual stocks to build up your portfolio, then a research and statistical data oriented approach is likely to be more helpful. To do so, not randomly choosing stocks that have high stock prices or have been recommended by some friends or family is essential. Rather, analyzing a companies’ fundamentals from annual reports and financial ratios is a better way of choosing stocks that would give you higher returns. Investing your hard-earned money into stocks that were just recommended by some friend, broker or "market predictor" on the television is definitely something that is not recommended as these stock suggestions usually reach the end investor after its price has already been saturated to the limit.
Another important aspect for diversification of individual stocks is to divide them proportionately between large-cap, mid-cap and small-cap companies from the stock exchange. It is a very widely believed myth that only large-cap companies with the largest market capitalization are the ideal stocks for high returns, but the fact is that small and mid-cap companies have a larger scope for growth if they have been carefully researched upon. However, it is true that these smaller companies do not have a wide range of research and information available, but some analysis methods used for the available information can help with the requirements for choosing those particular stocks.
Next up is diversifying across different countries to reduce your portfolio’s risks for the long run. As the mechanisms of all countries’ economies function differently that varies upon multiple factors like its population, available resources and social attitudes. Limiting your investments to only one country would be like putting all your eggs in one basket.
All throughout history, every country has risen back with tremendous growth after bear markets (a prolonged drop in investment prices), the only exception being Japan after their economic crash that is also known as the “Lost Decade” from the year 1991 to 2001 and hasn’t been able to get back to its original position till now. If an investor would have invested in Japan’s index fund- Nikkei before this crash, their investments would have faced a loss of 43%! Therefore, it is utmost important to diversify across at least 4-5 countries.
To collate, the more you diversify through every aspect possible, it makes your stock portfolio not only provide you with tremendous returns, but will also be a strong and sustainable portfolio that has the capability to last through thick and thin.
~Shagun Johrii
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