3 reasons why Diversification matters (v2)

We’ve all heard the ancient adage “Don’t put all your eggs in one basket”.  This applies to even the minute aspects of life, including how you allocate the wealth in your portfolio.

But, why is “diversification” the catchphrase among financial planners and investors in India as of late?

Here are the top 3 reasons why diversification is making a buzz in the investment community.

1. Greatly reduces the portfolio volatility

Strategically diversifying your portfolio is tough. Dealing with massive losses from volatile markets? Even tougher. Diversification helps to take away fluctuations in certain markets and ground them in more secure asset classes.

Through diversification, you can “cash out” part of your notional wealth in equity and real estate holdings. The advantage of this? Reallocating your assets to a sector that can give you more predictable returns and protection.

2. Helps you protects your wealth

Investments in diverse sectors, such as non-cyclical asset classes, are more stable and less influenced by movements in the economy. Why is this important? These sectors can hedge certain markets, like equities, that you may have in your portfolio.

An example

Curious to know which asset classes are independent of negative economic cycles? Here’s one you may not have thought of: Businesses offering fundamental services.

The health care industry in the United States offers such fundamental services. With most of its expenses coming from the government, US healthcare spending doesn’t depend on movements in the economy. The returns generated from such a sector are not only low in volatility, but also yield significantly high as well.

3. Paves the way for predictable returns

An equally important benefit of diversification is predictability of returns. Equities, with their sensitivity to market corrections, and Fixed Deposits, with their lofty taxes and low yields, do not deliver consistent returns.

On the other hand, fixed income instruments offer far more attractive yields. They are also more secure, allowing one’s returns to grow steadily.

Why Invest Now?

In recent years, global liquidity has continued to surge with the help of central bank policies. Liquidity has boosted the prices of asset classes, driving gains in EM equity markets to new thresholds.

But, are the fundamentals really catching up with the valuations? This seems to be a bit unclear at this point in time. What does this mean? The sustainability of equity markets is not always guaranteed and susceptible to movements in the market.

In other words, why not play your cards right and diversify to avoid this uncertainty?