It is important to have a diversification strategy. 2020 has suffered hugely due to the pandemic of Covid-19. It has forced people to rethink their financial plans. Having a well-diversified portfolio reduces the losses during market volatility. The current health crisis has shown the benefits of having a balanced portfolio. Moreover, those who didn't have a balanced portfolio have suffered. So is this an end for them? No. They can still diversify and benefit from it. We discuss the benefits of diversification in this article. Let's begin!
In This Article
Diversification strategy in 2021
For those of you, whoever had any doubts regarding the diversification of their investment portfolio, they have all been settled in this pandemic. Moreover, there is market volatility due to the pandemic. Also, stock prices are fluctuating due to the Covid-19 situation, and various governments have announced packages.
As we know more about the pandemic's impact on the world economy, one thing is subsequently certain. Businesses will be facing a hard time.
Prior to talking about diversification strategy, we will discuss the differences between diversification and hedging. Because in crisis situations like the pandemic, while it is helpful to diversify it is harmful to hedge. To get a better understanding, we analyze correlation.
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What is Correlation in Diversification strategy?
Correlation means how two different variables are related. Subsequently, in investing correlation means how two securities are either moving in the same or opposite direction at the same time. Moreover, it is applied in advanced portfolio management and ranges between -1 and +1. It is an important part of the diversification strategy.
|Example 1: Inflation vs Rent||Example 2: Interest rates vs Bond yield|
|When inflation increases, general prices across the board increase as well. Rent of property increases too. Thus, this is a positive correlation.||When inflation increases, the interest rates increase, and consequently bond yield decrease. Thus, this is a negative correlation.|
Ignore Lum-sum Investing
Ignore investing a big amount at once: As we are clear about diversification, it is important to not invest a lump sum amount at once. It is easy to fall for low market prices and invest a lump sum amount. To think that the market has reached its bottom point will be a mistake.
The markets are unpredictable in such a crisis. Timing the markets is a big gamble if the markets further go down, you might suffer big losses.
Consider Systematic Investment Plans
Systematic Investment Plans are a good way to invest: SIP’s are particularly helpful during market volatility. Subsequently, you have to invest a fixed amount at regular intervals and the market conditions do not matter. Consequently, the investor benefits from the Rupee Cost Averaging as the average purchase cost reduces and decent gains are made.
Long-term equity investment: Thus, you now know that you should invest in securities with minimum correlation, not investing a lump sum amount, and think about SIP’s. The next issue to consider for investors is their investment duration during volatility.
Short-term investors suffer the most from a volatile market. If past performance were to be looked at, they will thus explain that markets are always volatile but they subsequently recover from the crashes and correction.
Though past performance is not a guarantee of what the future holds, the economy consequently returns to normal in the due course of time. A long-term investment is something you should strongly consider.
In the investment world, it is known as diversifying a diversified portfolio. Let’s assume that you invest 50% of your portfolio in equities, 20% in debt, 20% in stocks, and 10% in deposits( just an example and NOT A RECOMMENDATION). Moreover, this is the first level of diversification and depending on your portfolio, you can thus choose the following options.
1. Diversifying equity funds across sectors
Due to the pandemic, most sectors of the economy are thus hit. If you feel inclined to invest, you should look for those sectors which have the capacity to turn around once the economy recovers. Banking, insurance, healthcare, etc. are some of the places which can be looked into.
2. Diversifying debt investments
Generally, most investors prefer equity to diversify. Debt classes can be a good option as well. Even under debt classes, they either invest in debt funds(considered secure) or invest directly in some debt instrument without checking the correlation. Under the current situation, you should diversify within the debt class too.
Income funds, fixed maturity plans, dynamic bond funds, etc. are some of the many other debt funds that can thus help you in diversifying your debt portfolio.
3. Invest in different market caps
It is always wise to invest in a company with strong fundamentals during crisis times. But in case your portfolio is already invested in large-cap and blue-chip companies, you can invest in small-cap companies through such funds. This will help you diversify across different market caps.
The current pandemic has created a lot of fears. We understand your emotions and it is not easy to move ahead in such times. But we strongly discourage you from redeeming your investments. Moreover, you should invest in a calculated manner. You should remember that panicking will cause you further losses.
If you feel that the volatility of the markets would continue and the recovery can be in a sooner time, you can book your loss. Subsequently, you can go for a better portfolio suited to the current situation. Finally, the three rules of a successful investor are risk tolerance, not losing focus of their financial goals, and investment duration.
Be it reclaiming your invested money back or entering the market when it is at the bottom, follow the three rules. Happy investing!
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