Diversified Investment: What is it & How Does it Work?

Diversified investment refers to investing in a mixed variety of instruments within a portfolio. A typical diversified portfolio consists of a mixture of asset classes such as stocks, bonds, fixed deposits, cash, commodities etc. The diversification of funds essentially helps in minimising the risks in your portfolio by limiting the risk exposure to any single asset or investment.The rationale behind this kind of investment strategy is that different asset classes react differently to the same economic event and hence, the risk is distributed as well. In a diversified portfolio, when the value of one asset rises, the value of another one’s fall. This balances out the overall risk and irrespective of the market scenario, the overall portfolio gains.

• Stocks and mutual funds usually do well when the economy as a whole grows. When you invest in a company’s stocks or mutual funds, you own a part of that company. When the economy is booming, the companies tend to make more profits which increases the prices of their stocks and mutual funds. As a result, an investor in these asset classes gains. However, investment made in these assets are riskier since their values can rise or fall quickly, depending upon the market conditions.
• Bonds and other fixed income securities such as fixed deposits do well even if the economy is not doing that well. These are more suited for risk averse investors who are willing to trade lower returns for that reduction in risk.
• The values of commodities such as oil, wheat, gold, real estate etc. depend on the supply and demand factor. For example, if there is a drought like situation, the prices of wheat can go up and investing in it can fetch you very good returns. Similarly, with the increasing population, real estate prices are soaring which makes it a good investment avenue.

Now, consider a situation when all of a sudden, the share market plunges due to an unexpected economic slowdown. In such a case, the value of your investment in stocks and mutual funds will go down drastically and you may incur a huge loss. However, if you’re also holding investments in fixed income asset classes, they will continue to perform without being affected from the ongoing scenario.Then, the cumulative return generated from your investments will help in balancing the overall loss and reducing the risk in your portfolio. To Sum it Up A diversified investment is a mixture of different asset classes with an objective to gain maximum returns with minimum risk. Based on your investment objective and risk appetite, you can diversify your portfolio by including a correct mixture of stocks, fixed income securities, and commodities.

The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.