Diversification is more than holding different types of investments like stocks and bonds. It is also important to diversify within your stocks and bonds. Within your stock piece, it is important to allocate to companies within different sectors of the market i. It is also important to diversify among size of companies in terms of their representation in the overall market. Within your bond piece, it is important to diversify among different types of bonds i.
Different types of bonds respond differently to a change in interest rates so spreading funds among various types can help reduce interest rate risk as well as default risk risk that the corporation, for example, goes out of business and cannot pay interest or return principal.
As you might suspect, diversification can be challenging because it requires an investor to make an informed investment decision on a number of investments. Those that do not believe they have the time, knowledge or desire to do the research required of diversification may elect to diversify by using mutual funds or ETFs. Through these vehicles, investors can delegate the research and selection process to the fund manager who pools your funds with other shareholders to buy a large number of investments.
Clients will often explain to me that the reason they have so many accounts spread across different companies is to diversify. This may have been necessary 30 years ago, but today you can buy the same stocks and ETFs through TD Ameritrade that you can through Schwab. Most large brokerage firms have selling agreements with the major mutual fund companies to offer their funds as well i.
Vanguard, American Funds, Fidelity. Diversifying across firms makes it increasingly difficult to manage your investments effectively. Putting together a clear picture of your portfolio and gauging performance will take a lot of manual work and tedious calculations from your statements.
Diversification can go wrong on either extreme, too little or too much. Opinions vary on the amount of exposure percentage that should be allocated to a particular investment.
Over-diversification occurs when an additional investment lowers the potential return more than it offsets the potential risk.
Over-diversification can also be sectional in nature. Sectional over-diversification occurs when there are a large number of investments in a particular industry and the behavior of the investments is quite similar.
Under these types of investment, you can withdraw a fixed amount monthly or quarterly. You can customise withdrawal, opting for a fixed amount or against profits. A similar alternative is systematic transfer plan or STP where you can transfer a fixed amount between different mutual funds.
STP helps to maintain a balance in your portfolio. In either case, the objective is to provide access to investments at fixed intervals. An investment plan is essentially your long-term saving plan. So, you have to start thinking long-term and avoid knee-jerk reactions.
Think buy-hold instead of a constant trading strategy. It means keeping a relatively stable portfolio over time, irrespective of market fluctuations. Before investing in financial markets, you need to first understand the factors that influence its movement.
Financial markets include stock exchanges, foreign exchanges, bond markets, money markets, and the interbank markets. These are essentially a marketplace for financial instruments and, like any other market, they function on demand and supply. Like any other market, there are also external factors like interest rates and inflation that influence its dynamics. The other major influence is the central bank, the Reserve Bank of India and its monetary policies. Global markets have the potential for high returns in a short time.
These markets are usually characterised by an extremely fast-moving dynamic where an investor must also deal with multiple monetary regulations. As a young investor, it can take some time to learn its functioning, understand trends and fluctuations, and what drives these shifts.
But it can be highly rewarding, especially when the Indian market is experiencing a sustained downturn. You can start with an exchange-traded fund ETF or a mutual fund with a low-cost structure and ample liquidity.
It will allow you to invest safely with a small amount of capital, giving you the perfect opportunity to observe and understand how the global market works. Balance is important in life and in investment. It is important to periodically check your investment portfolio to check the balance of various assets. This review should be based on your goals and major life milestones along with evaluation of where you started from and how far you have come.
This exercise also makes you more disciplined about your investment, while keeping you aware of its yearly growth. These two factors will eventually help you make more informed decisions, while developing a finer insight into investments in the future. If you have a small amount that you want to invest over a given time rather than investing a huge amount at one time, a SIP is a good option.
Under this method, you can invest a fixed amount in mutual funds at fixed intervals. It is ideal for those who do not have access to a large amount, but can afford to invest only a small sum each month.
SIPs are also ideal for young investors because they help you inculcate discipline in your investment strategy. The investment amount gets deducted directly from your bank account, getting you used to the idea of setting aside a fixed amount regularly, for your future. Since it is based on compound interest with low overall risk, it also allows your investment to stay safe. But remember, diversification is again the key. Invest in different types of industries and interest formats. Few young adults in India think of investing in life insurance.
It can be difficult to imagine death, as a youth, especially if you are not married or have other dependents. But the age-old advice of treating life insurance as an essential investment avenue holds true, especially when you are young owing to the low premium rates your insurance company is likely to offer you at a younger age.
Life insurance companies decide premiums according to age, and the younger you are, the lower your premiums. Life insurance may not benefit you now, but it will safeguard your loved ones when you are not there. You can also earn on your life insurance by investing in unit linked insurance plans ULIPs , which combine life insurance with market-linked investments.
A portion of the investment amount goes towards the insurance premium, while the rest is invested in the market. This is a long-term plan, and an early start can help you invest for future milestones. Remember to compare different ULIPs before investing.
Table of Contents. Scenario: Susan, 55, has spent her entire career working and investing in the technology industry. Large Cap stocks. Step 1: Identify Objectives and Constraints Through a series of conversations, Susan identifies a few objectives and constraints: She would like a high probability of her portfolio funding her lifestyle over the next 40 years.
Otherwise, she would like to build a portfolio that optimizes for 1. Step 3: Manage Taxes Now that the target is identified, the hard work of moving to the target while minimizing taxes begins. Susan sets up a Donor Advised Fund DAF that allows her to get the tax benefits of the donation today while she is in a high tax bracket, but is still able to immediately diversify the position and gift the money to charities of her choice over time.
Like DAFs, CRTs are a potential strategy to make a one-time charitable contribution and receive the tax benefit in year one and maintain the ability to distribute the funds down the road. However, unlike the DAF strategy, CRTs can be set up to provide income to the donor or their beneficiaries over their lifetime.
A CRT works as follows: Individuals place assets cash, publicly traded securities, real estate, some private company stock in a trust; A tax deduction is taken in the year the CRT is setup; You, or your beneficiaries, receive an income stream from the assets; And lastly, based on a pre-defined timeline or the death of the last beneficiary, the remaining balance of the CRT is distributed to the charity of your choice.
While similar to Indexed Mutual Funds or ETFs, in that they are low costs and diversified, the Direct Indexing Solution allows Susan to customize her portfolio and manage taxes at the individual level.
Additionally, she is able to manage the tax impact and spread out the gain over time, and offset some gains through tax-loss harvesting in the account. Lastly, because her k is not subject to taxes today, Susan is able to sell the equities in that account and buy bonds to round out the allocation.
Step 4: Enhance Returns The last step is to make sure her overall allocation is balanced so as not to miss out on the areas of the market that are generating returns. Source: Dimensional Funds Her diversified portfolio that ensures she is balanced at the company, industry, assets class, strategy, and geographic level might look something like this: Source: Cordant.
And optimizing your portfolio diversification strategy is one way to do just that. This website uses cookies to improve your experience. Manage consent. Close Privacy Overview This website uses cookies to improve your experience while you navigate through the website. Out of these, the cookies that are categorized as necessary are stored on your browser as they are essential for the working of basic functionalities of the website. We also use third-party cookies that help us analyze and understand how you use this website.
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