An age-old saying is, “Don’t put all your eggs in one basket.” The main reason behind this saying is that there is always a risk in investing money in financial markets. That is why here we are going to discuss Why do I need a portfolio.
There are two types of risks with investments in financial markets – systematic risk and unsystematic risk. Systematic risk is the kind of risk that is inherent to the whole market.
On the other hand, unsystematic risk is that risk that is related to a specific company or industry.
Unsystematic risk is the kind of risk that can be reduced to a certain extent, especially through diversification. Let us see why and how this diversification is important.
Why Diversify portfolio
Diversification is basically a technique to manage risk by the allocation of one’s funds in different financial instruments. Let us understand the question about why to diversify with the help of an example –
Let us say that a stock investor has a piece of good knowledge about the pharmaceuticals sector and therefore invests only in pharmaceutical stocks.
In case of any adverse news for the pharmaceuticals sector, the portfolio of stocks of the investor would show a considerable hit.
On the other hand, there is an investor who has his capital divided among various stocks belonging to different sectors. His funds would not take a sudden hit in case of any bad news for anyone particular sector of the economy.
Similarly, it is imperative to diversify even in different types of asset classes. In India, common asset classes in which the majority of the people invest in are stocks, real estate, cash, commodities, etc.
Having a portfolio is one of the wisest financial decisions one can take. Although managing a portfolio would require some serious thinking and skills on one’s part.
A portfolio should be made according to the risk appetite, age, and financial obligations of an individual. The more diverse it is, the safer it is.
Now, let us see some more benefits of having a well balanced and diversified portfolio
1) Meeting Long Term Financial Aims – Since the capital is diversified among different financial instruments, it is quite possible that even after having some losses, the financial target is achieved.
2) Reduces Risk – Not all the sectors of an economy start performing badly simultaneously. Therefore, let’s say, if some loss has been incurred in real estate, it is possible that good profit would have been earned in mutual funds or stocks, etc.
This reduces the risk factor on the overall portfolio of an individual.
3) The Benefit of Shuffling Investments – This is an important benefit of having a good portfolio. If one can identify the signs of the upcoming poor performance of a particular asset, then the funds allocated to that asset can be withdrawn and invested in another good performing asset.
It has been established that making a portfolio of all the funds one has, is one of the wisest financial decisions one can make. One can choose a fine mix of cash, stocks/mutual funds, real estate, fixed deposits, commodities, etc.
This is important because one must always prepare for unavoidable risks in different financial instruments at every point of time.
In uncertain times, when one asset class is not performing well, an investor can be benefited from some other asset class. The returns from one good performing asset can offset the losses incurred due to some other asset class.
Therefore, spend some time analyzing your financial needs and risk-taking capacity and make a portfolio according to your age either by yourself or taking guidance from professionals.
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