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Diversification is an investment strategy that suggests owning several different investments that tend to perform well at different times to cope with the effects of market inflation. Fund managers employ several techniques and their knowledge and experience to select uncorrelated assets. These assets provide us diversification which acts as a fallback option in times of crisis. 

In general, investing in bonds, stocks, commodities and alternative investments dampen the overall volatility of an investment portfolio. Smart diversification absorbs the losses of one asset and balances them against the gains. Investors should find a combination of investment opportunities that fit their long-term objectives and risk tolerance.

Why diversify?

The objective of diversification is not to eliminate risks or guarantee returns. It rather casts a safety net that reduces your investment risk and enables you to limit your losses by optimizing returns. Solely relying on just one mutual fund can put you in trouble during economic fluctuations; at times, it can even lead to capital erosion and incurring losses on your hard-earned money.

Mutual funds portfolio diversification aims to achieve the twin goals of maximizing returns and minimizing risks. Moreover, even after creating diversified portfolios, it is really important not to limit the task of diversification. According to the market conditions, these portfolios should be subjected to change to gain the maximum profit.

As far as financial goals are concerned, portfolio diversification would ensure timely achievement of each goal as per the varying investments horizons associated with it. However, on the flip side, the failure to achieve the goals would have severe implications.

Benefits of diversification

Helps reduce risk.

The actual returns on investment can never be predicted. It is only by spreading the investments across different equities such as bonds, shares, and real estate that risks are reduced. It ensures that high returns in the other offset the loss in one category. Similarly, investments with varied maturity can be considered in the debt segment.

It helps you avoid losses arising due to bad timing. 

The advantages of a well-diversified portfolio can be seen over the long term. Investors often make emotional decisions owing to the market movements instead of following a financial discipline. People tend to enter markets when they are climbing higher and panic when the market fluctuates and sells their shares. As a result, it generates lower returns on investments than the market average. Maintaining the optimum level of risk and diversification in your portfolio will ensure that financial discipline pays off well and prevents losses in the long run. 

Diversify based on an asset allocation that suits you.

It refers to getting the right mix of investment options best aligned with the risk profile, time horizon or life stage. Maintaining regular checks is necessary to ensure risk tolerance and achieve our investment goals.

Diversification of investment portfolios based on our asset allocation strategy is the key to wise investments.

Ways to diversify your mutual funds’ portfolio 

1.Diversification across asset class 

It consists of diversification across different asset classes. For example, people holding equity funds can diversify their portfolios by investing in hybrid firms and old debts. The major benefit of diversifying across class assets is that if one asset underperforms, the other asset acts as a cushion against the losses.

2. Diversification within an asset class

This form of diversification includes investing in different mutual funds within the same asset class of equity and debt. It spreads our funds across different securities in the chosen asset class. Such forms of diversification reduce the risk associated with a single asset class and absorb the fluctuations. 

3. Geographical diversification 

Another way of diversifying your portfolio is through geographical diversification, which involves investment across different locations or countries. Investors go for this diversification to reduce the risk and enhance returns. In addition, it involves investments in markets across the globe that are not correlated. Therefore a change in the price of one asset would not affect the other.

Problems with diversification

Even though there are added perks to this diversification process, there is a downside to this whole process. First, investors go through a lot of speculation keeping in mind the flip side of diversification. In addition, it may be cumbersome to manage a diverse portfolio when we hold multiple holdings and investments.

Diversification can also be expensive, and the costs can be too much to bear. Different investment instruments have costs, so buying and selling them will affect your bottom line. Even though higher risk comes with higher rewards, it may limit your returns.

Complications should be kept in mind before making any investment. For example, many synthetic investments products have been created to accommodate risk tolerance. However, these products are complex and are difficult for beginners to comprehend.

Unfortunately, even the best analysis cannot guarantee that a company will not incur losses. Diversification won’t prevent a loss, but it would reduce the impact of fraud and wrong information on your portfolio.

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