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Breaking a bigger problem (risk) into a minimal or manageable one – this is what diversififying does to an investment portfolio. Mutual fund diversification, also known as asset allocation, is a strategy that helps to manage unsystematic risks in investment. The agenda of diversifying is to lower investors’ risks. Let us see how this tactic helps in mitigating potential capital loss.
The ultimate aim of diversifying is reduce risks in mutual fund investments. This helps achieve higher yield returns on average. Thus, it cushions the negative impact of the adverse performance of any one (or a few) security in the overall portfolio. The practical application of diversification to a first time investor may seem overwhelming and even intimidating. However, the concept of this theory is quite simple. Let us elucidate it in three steps as given below.
i. An investor must first build a portfolio with the inclusion of various different investment instruments. This could range from options like stocks and bonds, to cash mutual funds and so on.
ii. The second step o diversify involves sorting the risk element of various investment schemes. You can do this by picking securities with diverse risk levels.
This way, even if you face loss in one, the gains from the others can compensate for the that.
iii. Diversification can also be across different industries. It is important to take into consideration and pick securities according to industries in order to minimize the industry-specific risks. iv. Success of a diversified portfolio depends on the skills of the fund manager. It is the manager who decides when and where to invest.
There are certain investment instruments that tend to perform better than their counterparts. This depends factors like the prevailing interest rates, the market conditions and the performance of the currency market. It is important to note that diversification does not completely avert the risks. Rather, it can only minimize the impact of the loss on the investing portfolio.
Investing in mutual funds that invest across a broad range of assets is one way to spread the risks. For instance, exchange-traded funds help reduce exposure to your portfolio of investments that form a certain index.
It is clear that diversification forms one of the most important principles in investing. If one seeks to grow their portfolio it is vital to diversify their investment.
Thus, diversification helps investors achieve consistent returns on investments and ensures a smoother performance of the portfolio. Investing with ClearTax Save can help you gain a diversified portfolio in a hassle-free manner. We have handpicked top-performing funds that suit diverse investment needs for your convenience. Start investing.