Why Diversification Is the Most Important Thing That You Need to Learn About Investing

Why Diversification Is the Most Important Thing That You Need to Learn About Investing

Why Diversification Is the Most Important Thing That You Need to Learn About Investing 

Investing is a concept that may take years to master, if you spend enough time understanding the various permutations and combinations. For a newbie investor, the jargon may seem mind-boggling but worry not, you are not alone! Even experienced investors fail to get everything right, for that is the nature of the beast called the market. However, if there is one thing you must know, the most important thing that you need to learn about investing, it is diversification. Ask any investor who has spent some time trying to figure out the market and they will, invariably tell you that it is diversification that saves the day, always. What does portfolio diversification mean and how can it help you overcome the pitfalls and hurdles in the jungle that is investing? Let us consider a few simple case studies for clarity.     

The nifty umbrella vendor

Once upon a time, there was an umbrella seller, who made profits come rain or shine. How did he manage to do that, when the rains last but only a season? Well, his secret lay in the fact that umbrellas were only a part of his business. His shop also offered customers a variety of quirky and cool sunglasses, ensuring that he was never caught on the wrong foot. Be it the rainy season or hot weather, people flocked to his shop to buy the essentials and he laughed all the way to the bank. If he had stuck to just umbrellas or sunglasses, he would be taking on unnecessary risk and his income would be relegated to just one season. However, his excellent diversification skills allowed him to make the most of the seasons, without depending on just one variable for income.

A diet that finally works

Now let us consider another instance, where you or a friend decided to try out one of the fad diets circulating on social media. The most popular among these could be the ketogenic diet, which prompts practitioners to avoid carbs and stick to high intakes of fatty food. If you have followed the keto principle, you know how difficult it is to maintain. Sure, you may enjoy consuming large quantities of chicken or cheese once in a while but it is extremely difficult to just stick with high fat food items on a daily basis. Alternatively, you may have tried the high carbohydrate diet which cuts out other sources of energy.

What is the common thing we notice in all these diets? They limit the intake of multiple food groups and only focus on one category, making it monotonous and difficult to sustain. Over the long term, these fad diets may also end up affecting your kidneys or other organs. A simple and healthy alternative to such diets is consuming a healthy but controlled meal, with diverse food categories offering you all the elements you need to maintain a healthy body. In addition, the variety of food items that you can consume, though in limited quantities, makes this diet more fulfilling and, therefore, easier to sustain. 


A portfolio that takes you all the way

Similar is the case with portfolio diversification. There are a variety of asset classes that you can invest in, but sticking to just one category sets you up for high risk and an increased possibility of losing your hard-earned wealth. You must have heard of how stocks are a sure-fire way to get rich. Absolutely, the stock market has immense potential to boost your wealth, but only if you tread carefully. If you end up investing all your money in the market, you could see your wealth get wiped out during one of the many crashes that plague the market. Contrarily, if you are too afraid of the market and invest only in debt funds or bonds, your wealth may not grow in line with the rise in inflation or the growth of the economy. This will cause you to lose out on the potential returns you could have earned. At the end of the day, despite investing, you might not generate sufficient returns to achieve your financial goals. 

Does that mean that you should only invest in debt and equities? Well, no! Optimal diversification involves investing in a variety of asset classes, such as equities for high returns, debt for safety, gold and commodities for hedging, and real estate or FDs for additional security. Each of these classes have a different role to play, and diversification helps you gain the benefit inherent in each of these disparate categories. For instance, when the equities crash, you might see your investments in debt and gold earn higher returns and vice versa while real estate investments help you benefit from the rise in property prices. Indeed, portfolio diversification saves the day, whether markets trend up or down. Add to it the fact that portfolio diversification offers you peace of mind in all market scenarios and allows you to take a break from timing the market, and there is no downplaying the importance of diversification when setting out on your investment journey.  

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