From an early age, we are taught not to keep all eggs in one basket. Not realizing it then, but this was one of our first lessons in portfolio management and diversification.
As the saying goes, concentrating your assets may make you rich but diversifying your assets keeps you rich.
Diversification helps divide risk in the portfolio. However, too much diversification will hamper returns on the portfolio.
Expert investors do not prefer a too diversified portfolio. Legendary investor Warren Buffett says ‘Diversification is a protection against ignorance. It makes very little sense for those who know what they are doing.’
His partner and long time friend Charlie Munger is of the opinion that ‘The idea of excessive diversification is madness. Wide diversification, which necessarily includes investment in mediocre businesses, only guarantees ordinary results.’
Their point is that if you know how to pick and monitor your investment, you can keep a concentrated portfolio. But for most of us who are not as savvy as these investors, we need to diversify our portfolios.
But portfolio diversification cannot be random. There is a science behind creating a portfolio, depending on various factors like risk taking capacity, age of the investor, financial goals, among other factors.
Let’s first define a portfolio
We shall now look at various kinds of portfolios.
It is not advisable to build an aggressive portfolio at the start of one investment journey. One needs to have a good knowledge of both fundamental and technical parameters to build an aggressive portfolio. Such a portfolio needs active management and can be built by professionals or people who have more time and knowledge to spend in the market.
A Defensive portfolio is a good entry level portfolio, where the chance of going wrong is less. Even if one is wrong in timing an entry, blue chip stocks, in the long run, have always given money.
If one needs to stick to investment in equities, then there is a high chance that an Income Portfolio may look like a Defensive Portfolio.
The ideal time to build an income portfolio of stocks is when markets are depressed and we are able to get companies at a good dividend yield.
The portfolio investor needs to have a good understanding of the market and a general idea of how stocks will react to news or development. Such an investor has a nose for smelling opportunities in the market and is in the game only until the opportunity is there.
Conclusion
Building a portfolio is a journey. One can change from the type of portfolio one wants to build based on various factors like returns, age, excess capital in hand, knowledge of the financial markets, and risk taking ability.
A portfolio is created by investing in different kinds of financial assets to achieve a financial goal. These assets can range from bonds, equities to real estate and paintings. There can be further diversification within each asset segment that will depend on the goal of the investor.
A portfolio is created by investing in different kinds of financial assets to achieve a financial goal. The portfolio is designed based on the return expectation and risk taking ability.
The return expectation of a portfolio depends on the selection of assets under it, which in turn is dependent on the risk and return the investor is willing to take.
There is no 'best style' of a portfolio. The type of portfolio to select should depend on the return expectation and the risk involved. An investor doesn't have to stick to one kind of portfolio throughout their life. As they achieve knowledge about the financial market they can graduate from selecting a very conservative portfolio approach to a more aggressive one.
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