One of the most basic and important tenets of investment planning is diversification, believed by many financial experts and financial advisors. Even though diversification brings down the risk of the investor’s portfolio, if not done in a calculated manner can prove disastrous.
Often, some investors tend to continuously buy mutual funds impromptu believing that they are diversifying their portfolio. However, this is a bad idea unless done in an effective and planned manner and does not add much value to your portfolio.
An investor can choose asset categories that go up and down with various market conditions in a portfolio, in order to save himself/herself from significant losses. As the market conditions effects each asset category differently, it is wise to invest in more than one asset category so that fall in returns in one category can be counteracted with another asset’s better returns. Therefore, if the right set of investments are made, you can limit your losses and decrease the fluctuation on the investment returns without having to give up on potential gain.
Asset diversification is also important as it will play an important role in helping you achieve your financial goal. Including assets with risk is also important as it helps you achieve a large enough return. However, do not go overboard on taking risks as you may lose your money even before you can use it.
Asset allocation or diversification of mutual funds largely depends on your risk appetite as well your time horizon. You can diversify your funds in the following ways:
When you diversify across classes, it is important you keep account of factors such as income, expense, age of investor and financial goals. Some investors also follow a diversification model appropriate to your risk profile.
Rebalancing your portfolio is crucial if you are considering diversification of funds. It involves re-alignment of the investment portfolio where you shift your risk-prone asset classes to safer asset classes as you move closer to your financial goal.
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