Why should an investor diversify his portfolio?

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Updated: Tuesday, February 19, 2013, 13:57 [IST]
 
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Why should an investor diversify his portfolio?

In an era where volatility and uncertainty abound, it's essential that you diversify your portfolio to hedge against any untoward risks.

Let's site a few examples, why it is neccessary to diversify your portfolio. Assume, you have invested your entire portfolio in equity and your have a Lehmann Brothers (or sub prime mortage type crisis) chances are that you will see a significant amount of your portfolio value being eroded.

Now, suppose you are risk averse and decide to put your entire savings in gold. The yellow metal has traditionally never given solid returns, except in the last two years. So, with gold you end up risk free, but with low returns. It's therefore essential to diversify your portfolio.

Below are some of the various investment avenues you should consider, with their pros and cons:

Equities: Equities are considered too risky and are highly volatile. So you need to invest only some amount of money as they do provide you with superior returns. The amount would depend on your own ability to take risk and your age profile. It would not be advisable for retired individuals to park sizeable amounts into equities.

Gold: Gold has only given returns in the last few years and is a risk free investment. However, it gives hardly any returns in the long term. It's a perfect hedge against difficult times.

Real Estate: Real estate gives you returns over a longer time frame only. The problem however is that they are not too liquid. 

Fixed deposits: Investing in FDs is advisable as they are highly liquid. However, in a falling interest rate regime, the real rate of returns might turn negative, if we keep inflation in mind.

Story first published:  Tuesday, April 17, 2012, 14:25 [IST]
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