Question

What is diversification and how does it impact the preferences of investors, as well as investments that fit into various risk categories? How might portfolio composition change as you age?

Answer 1

Diversification- It is an art of diversifying the risk by diversifying the portfolio and investing money into different asset group and class. Diversification reduces the risk for the individual and institutional investors. Unsystematic risk that is related to company or industry can be very well minimized through diversification.

It can be done:

By investing money into different stocks of different industries- One can invest his money into some of blue chip stocks of different industries so that he can take the benefits of all the industries and if one stock comes down or one industry is not doing wee, other is doing good, portfolio will be balanced.

By investing money into different Asset class- One can invest his money into equity, debt, money market securities etc. so that risk can be diversified and return of each and every instrument can be availed. Equity has high risk and high return while debt security has low risk low return, Government securities have no to low risk and lower but fixed return. In this way, portfolio will remain balanced.

By investing into Mutual funds- Mutual fund pools your money and further invests into many stocks of different sectors, mutual fund itself provides benefit of diversification so an individual investor who cannot choose stocks on his own, he can invest into mutual funds, equity or debt fund because mutual funds are professionally managed and also provide tax advantage.

Portfolio composition change as you age:

• If you are young- When you are young and below 30 years of age, you can take risk so you can invest 90% to 100% into equities for longer term for higher returns.
• If you are married with kids- If you have a family, you can invest 60% into equities and 40% into debt and fixed income securities so that you can get higher returns from equity and fixed and safe returns from debt security.
• If you are old and retired- If You are retired and you cannot take risk because at this age, people want to be at safer side so you can invest into money market, fixed income and debt securities so that you can get a regular and fixed income.