Good investment strategy is the key to achieve your financial goals. This can be done by minimizing risks and thereby maximizing returns. Risks can be minimized by diversifying your investments. In simpler terms it means `do not put all your eggs in one basket’. Your investments should not be focused on just one asset class. It should be allocated strategically in different asset classes. Diversified portfolios are proven to have reduced losses in events such as economic crisis or bearish stock market.
When you diversify assets, any downward movement in one class of asset is offset by growth in another class of asset. It is unlikely that all different types of assets will grow or decline at the same time. Each asset has its own benefit and by diversifying you get the advantage that they have to offer. The various asset classes are cash, stocks, gold, fixed deposit, real estate, provident fund, mutual fund and so on. These can be classified into aggressive, balanced and conservative assets. One can also further optimize your portfolio by diversifying within each investment class. For example, when investing in mutual fund, you can investment different funds such as small, mid and large cap rather than investing in only one fund.
Diversification of asset will depend on your age, financial goals, amount of investment, timeline and your risk appetite. An ideal investment portfolio should have mix of aggressive, balanced and conservative allocation. When you are younger, you can have increased exposure to riskier investment such as equities. These have higher earning potential but it can take longer to give expected returns. There is also need to have balanced assets which are mix of aggressive and conservative assets. Lastly, some allocation has to be done in conservative assets. These are considered safe investment avenues but have lower earnings potential. Liquidity is another aspect that you need to consider while choosing your investments as you never know when you will be in need of funds.
The thumb rule for asset allocation says that `100 minus your age’ is the percentage you need to allocate in equities and the rest in debt and cash. However, everyone’s needs are different and allocation should be done accordingly. A high exposure to equity may give you good returns but increase your losses if the market turns bearish. On the other hand, a conservative investment will be a safe option but it will not have the potential to meet your future needs. Thus, allocation will need to have a good mix of aggressive and conservative investments.
Once you have created a well balanced portfolio based on your needs you can stop worrying about your investments and let your money work for you. You will still need to monitor your portfolio occasionally. You should refrain from constantly adding or removing different assets. As you age, you can shift your preference towards a more conservative portfolio. Do keep in mind not to over-diversify.
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