A portfolio is essential in diversification of your assets. You should have heard the expression, “Don’t put all your eggs in one basket.” Diversification helps you reduce your exposure to a single sector/stock, and it’s not rocket science. However, keep in mind that ‘excess of anything causes more harm than good.’ Let’s look at both sides of the argument.
Diversification of your portfolio can help you reduce risk. It can also be used to make up for losses. The loss in one stock can be offset by gains in other stocks. Excessive diversification, on the other hand, may reduce rather than increase your returns. After all, quality trumps quantity. Although portfolio over-diversification is harmful, portfolio over-concentration is also harmful. The concentration of your investments raises your portfolio’s overall risk and volatility. If one stock does not perform as expected, your chances of earning high returns will diminish. If you haven’t diversified enough, your investment capital may dwindle as well.
Here are few suggestions that will help you build an ideal portfolio:
Invest in 15-20 shares: There is a significant risk of capital erosion if you have 4-5 stocks in your portfolio. It is the result of poor stock selection. Investing in 40-50 stocks, on the other hand, is not a good way to get high returns. As a result, 15-20 stocks are the best diversification mix.
Never invest more than 8% in a single stock: You can’t call it diversification if you’ve invested 30-40% of your portfolio in a single stock. As a result, it is not advisable to invest more than 8% of the total portfolio in a single company. And, as a general rule, 4-8 percent exposure to a single stock is considered appropriate. Now, if you also own mutual fundsand a specific company is included in that fund’s portfolio, you must consider that as well. Keep an eye out for this type of overlapping. Only then can you effectively diversify.
Invest in multiple sectors: Diversification should not be limited to a single industry. If you have concentrated your efforts in a single industry, a single unfavorable event could wipe out all of your gains (like the pandemic that destroyed the hospitality sector). As a result, you should include an ideal number of 5-6 sectors in your portfolio, with no more than a 25% investment in any one sector.
Invest in other instruments: An ideal investment portfolio does not consist entirely of equity. It achieves a balance between risk and return through appropriate asset allocation across asset classes. As a result, we present you with the best non-equity instruments to help you build an ideal portfolio. Gold, government bonds, commodities, and Cryptocurrencies are other investment options that you can keep a tab on.
To know more about portfolio creation strategy and management refer here. The educational module is made by industry experts and aims to make its reader a better trader and investor.