Diversification is predominantly a risk mitigation tool rather risk aversion. A pre-eminent rule of investment quotes, risks correspond rewards. With a greed for optimum returns, we tend to fall for the bait. Even falling for the bait, has become an implicit rule of investment. A justice weighing scale (in a courtroom) stays put balanced. To the contrary, investment weighing scale is seldom the same. For it remain balanced, the phrases “risks” & “rewards” should be archaic.
Let’s comprehend using an instance. An investor with a high risk-appetite (Quantum of risk, an individual wishes to bear) invests in below par bonds, in return for extortionate rates. If his luck and risk fructify, through bond redemption, the investor is rewarded. On the pessimistic side, the bond issuer might turn bankrupt and is implicitly rewarded by getting his dues waived off. Either stands atop, seldom both – reiterating the unbalanced investment weighing scale.
Investment avenues are plethora in count. Albeit, only a few enjoy limelight. For instance, GoI bonds were hardly tapped by retail investors. These bonds offer the stipulated return for a period of 7 years, with the caveat of no premature withdrawal. Had you been earlier for the bonds, you could have locked in for 8% – in 2018. Remarkably, 7.75% bonds subscription has ceased w.e.f 28th May 2020. Their rates could be tampered with, when subscriptions open up. With monetary easing, a given in the days to come, FD returns are bound to plummet. Rational investors should soon find an auxiliary for FD, as they will no longer reward them handsomely.
Global economies are bound to experience stagflation. Stagflation is a confluence of persistent unemployment with high inflation. Unemployment and inflation are either ends of a ‘tug of war’. A measure to control inflation would exacerbate unemployment and vice-versa. For instance, hiking lending rates would mitigate inflation, but funds turning costlier would hamper new investment and job opportunities. Adopting a balanced measure to mitigate both synchronously, would take years for an economy to recuperate.
At times of distress, it is savvier to diversify our investments. In fact, following diversification among investment parties in a chosen investment avenue would mitigate your risk. For instance, DGIC (Deposit guarantee and Insurance Corporation) provides FD (Principal+Interest) cover, restricted to Rs 5 lakh. The cover would apply on “per person – per bank” basis. So, diversify your FDs among various banks. With the insurance cover in hand, your invested sum shall remain safe even in a scenario like YES BANK 2.0!!
Not to forget, Franklin Templeton’s concentrated exposure on lower rated bonds, ushered itself towards fund closure. So, seldom invest your entire corpus in a single avenue / party. The collapse of the avenue / party would eventually collapse you. Even, gilt funds (Government backed securities) are no exception to it. Governments shall renege on interest payments, the moment financial emergency is declared. So always diversify!! Albeit, financial emergency in India has remained an unchartered territory, since independence.
At times of distress, gold gleams better. A portion of portfolio diverted on gold shall continue to outshine. Diversify your investments across multiple sector stocks, thereby eliminating unsystematic risk. Demarcate your portfolio for long & short term. The former can bear a higher risk appetite, but the latter should be risk free & liquid. Mutual funds are advantageous as they follow a strategized diversification. Diversification provides an additional layer of insulation for your returns, before they are affected by the warmth of negative territory. An economy as a whole shall seldom collapse, majority might but not all. For instance, pharmaceutical stocks are exorbitantly rewarding investors – with dividends and capital appreciation. A diversified portfolio with a portion for pharma stocks, shall recoup for the ones that continue to bleed. So, divide your portfolio into granular portions. Decide on the investment avenues and parties to invest with. Diversify your options.