Diversification involves creating or building an investment portfolio that comprises of securities spread across different types of mutual funds. Diversification helps to spread risk across various mutual fund investments. It also simultaneously reduces the impact of poor returns that may occur from any one investment, securing your portfolio. This is because the prices of bonds, mutual funds, listed property, shares, and other securities often do not fall and rise in tandem.
When one type of security is on the rise, another usually witness a decline. This has an impact on your portfolio’s overall performance and also makes your portfolio less volatile. The primary objective of diversification is to diminish the risk involved in building a portfolio.
There are many ways to diversify across asset classes. Asset allocation is a method of strategically dividing your investment portfolio among bonds, stocks, and cash and cash equivalents to help safeguard your portfolio from the rise and/or fall in any one investment.
Diversification with mutual funds
As you might know, mutual funds are the easiest way to attain diversification as well as asset allocation without in-depth knowledge and expertise on each asset class. By investing in mutual funds that endow in different asset classes such as debt funds, equity mutual funds, gold, etc., you can spread your risks across your portfolio.
So, which mutual fund schemes should you target to diversify your investments? Let’s look at some common types of mutual funds:
Equity mutual funds:
These mutual funds make investments in the equity market. There are numerous options available that may suit your risk profile and investment goals. You can go for any single scheme or a combination of small-cap, mid-cap, large-cap, and multi-cap funds.
These mutual funds invest in a mix of debt instruments such as money market instruments, corporate bonds, treasury bills (T-bills), commercial papers (CP) etc. Not only do these funds offer higher liquidity than traditional fixed deposits (FDs), debt funds also have the potential to yield higher returns over an extended period. What’s more, these funds are tax-efficient, especially when the holding period is longer than three years, owing to the benefit of indexation.
A diversified portfolio should be created to reflect your personal goals and your individual risk tolerance. Hence, always invest in mutual funds after carefully analysing your financial goals, risk profile and investment horizon. Happy investing!