➢ Diversification is a fundamental of investing. Oxford dictionary defines diversification (especially in business) as the act of developing a wider range of products, interests, skills, etc. in order to be more successful or reduce risk. Online portal Investopedia elaborates diversification as a risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique contends that a portfolio constructed of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio.
➢ Why Diversify? Diversification will safeguard your portfolio against total loss, hedge your investments to cater for market volatility and accommodate your financial goals at varying timelines. Ipso facto, diversification of the portfolio must take place in the under mentioned varied asset classes.
➢ Large numbers of asset classes, as follows, are available in the Indian market and it is important to understand their peculiarities before investing in them:-
❖ Real Estate. Investment in real estate can be done by purchasing residential or commercial property (land, bungalows or flats), REIT (Real Estate Investment Trust) or REMF (Real Estate Mutual Fund). Investment in real estate is capital intensive and thus should be done early in life by availing home loan option to avail its tax saving advantage. Even so, one must avoid using entire savings towards payment of home loan EMI and concomitantly invest a portion of it, preferably through SIP, to ensure wealth creation. To avail maximum advantage, investment in this asset is for long duration of at least a decade plus. Property market, which is fuelled by black money is on the decline due to Government instituted measures to restrict its use in the economy. Thereby, this asset may yield lesser returns in India in the coming decade. Retail investors should be wary of frauds and cheats galore in this sector and should carefully check the documents before striking a deal.
❖ Equity (Stocks). Investing in equity or stock market is a good option in the long run (minimum 7 to 10 years to ensure good returns). Investment in equity can be done directly by the investor through demat (dematerialization) account or through mutual funds (MFs) with high equity exposure. While the MFs are managed by professional fund managers, investments in demat account will require the investor to manage them himself. For this, the investor should be abreast with the market trends and carefully select the stocks (large, mid or small cap) based on his risk profile. Since 1990 till date, Indian stock market has returned about 17 percent to investors on an average in terms of increase in share prices or capital appreciation annually. Besides that on average, stocks have paid 1.5% dividend annually. A safe expectation would be 15 to 18 percent average return provided the investor stays invested for more than 5 to 7 years. It is felt that 100 minus your age is the percentage of your total net worth that should be invested in this asset class. E.g., if your age is 40 years then 100-40=60% of your portfolio must comprise of equity. Nevertheless, this is just a yardstick and one must seek his financial advisor’s advice before investing. The relationship between risk and returns in this asset class is directly proportional.
❖ Fixed Income Instruments. Indians by nature, especially the burgeoning middle and salaried class, are moderate or conservative investors. Probably, this was one of the reasons that helped us tide over economic meltdown of 2008 with relative ease. A wide array of fixed income instruments is available in India for a retail investor. To name a few – bank/post office fixed and recurring deposits/provident funds, Government/Corporate Bonds and plethora of Debt MFs. These instruments give an effective post tax yield of 6 to 8 percent per annum that barely beats the inflation. Moreover, the interest earned is also taxable in most cases that further compounds to the investor woes. However, these instruments are a good means of investment to give stability to your portfolio since erosion of principal investment due to market volatility is nil to bare minimum. As the investor’s age advances, these instruments become prudent investments for the elderly.
❖ Cash/Liquid. This investment is suitable for investors to cater for short to ultra short term financial goals. Investing in Liquid or money market/cash instruments is a good option since they have high credit quality and are highly liquid. Considering the low risk, the returns in these instruments vary from 6 to 8 percent per annum.
❖ Bullion. Traditionally, Indian investors are crazy about investment in gold. The market now offers gold Exchange Traded Funds (ETFs) that rule out physical holding of gold with freedom from ensuring its security. The latest Government launched Sovereign Gold Bonds is another good option since they carry sovereign guarantee, on the interest, and an individual is exempted from Capital gain tax arising on their redemption. They are available demat and paper form with a minimum tenor of 8 years with option to exit in 5th, 6th and 7th years. Another metal, silver is also a good option to invest. Bullion is good to hedge your portfolio against market volatility and about 5 to 10 of your net worth must comprise of this asset. Investing in jewelry is not a wise decision because you lose 15 to 20 percent of the asset value on each transaction due to non refundable labor charges. The best way for physical holding is buying coins & bars from reliable sources.
❖ Arts and Antiques. This form of investment is gaining ground for high net worth individuals or genuine art and antique lovers. This form of investment is fraught with danger of fakes and swindling. However, a genuine masterpiece can fetch you your asking rate if the buyer needs it.
➢ Is it prudent to invest in all the above asset classes? The answer to this question will depend on the investor’s risk taking ability based on his age, financial goals and cash flow. Ideally a twenty to thirty year old investor starting his career must invest 80 percent in equity, 10 to 15 percent in fixed income and bal in gold. During his middle age, he must invest in real estate to own a shelter by the time he retires and avail tax benefit. However, he must continue his equity exposure after moderation to take care of his home loan. During his sunset years, he must reduce his equity exposure and enhance his fixed income exposure to safeguard his principal investment and also get assured monthly income from investments.