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What is Diversification? Different Types of Diversification
An investor education & awareness initiative.
Everything that you do, there are a variety of options to choose from. Whether selecting a flavor of ice-cream, or the clothes to wear. Do you select the same flavor of ice cream or the same set of clothes every time? When it comes to investments, there are also a range of options available. It is important to work out the right option. The same option will not suit your needs every time. You really need is a large set of options to choose from which can take care of your requirements. It is easier to understand with an example. Suppose you invested in stocks or shares of an airline company. Your friend Arnav invested in airline stocks and in FMCG stocks. Your cousin Tanya, on the other hand, invested in airline stocks, FMCG stocks and gold. One morning you hear that the airline staff is going on strike. You start fretting because the value of your airline stocks goes down. All three of you lose some money. However, Arnav and Tanya were not as worried as they had other investments in their portfolio and hence are exposed to less risk than you. A few days later the government announces a policy that negatively affects exports and imports of the FMCG company. Arnav and Tanya both lost money as the value of their FMCG stock crashed. At the same time gold prices rose smartly which helped Tanya balance her losses and maybe earn some profit. What did Tanya do right? She was a smart investor as she diversified her portfolio better than Arnav or you. She ensured that she bought a good mix of assets with different features to better withstand the volatility of the market. Even if one part of her investment portfolio went down, the others could balance it out. Therefore, diversification is a risk management practice of ensuring that your portfolio has a balanced mix of assets, in order to withstand market volatility. The practice is done across asset classes (such as equities, fixed income, cash, gold and real estate) and within each asset class (for example, in case of equity, across geographical regions, industry sectors, market capitalization, etc.). Experts suggest that a well diversified portfolio will better manage the risk you take and usually ends up delivering better results for your portfolio in the long term.
Key Takeaways
Disclaimer: All Mutual Fund investors have to go through a one-time KYC (Know Your Customer) process. Investors should deal only with Registered Mutual Funds (‘RMF’). For more info on KYC, RMF & procedure to lodge/redress complaints, visit dspim.com/IEID. This is an investor education & awareness initiative by DSP Mutual Fund.
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