Putting all your eggs in one basket is a risky decision. Therefore, an important principle of investment is to diversify your portfolio. Spreading investments over multiple, unrelated products reduces the risk of a sudden, unexpected outcome.
In a diversified portfolio, a loss (risk) in one product is offset by gains from another product. As such one can expect to get decent returns, though the returns would not be exceptionally high or exceptionally low. Typically, the higher the risk you take, the higher the returns you can expect. Hence, every investor must think about how much risk he is prepared to take on.
One can invest in equity, debt, gold, real estate etc. Each class has different levels of risk and offers variable levels of returns. By diversifying the portfolio of investments across multiple asset classes, one can generate high returns for a given level of risk. Equity has high risk but also have the highest potential to give high returns over the long term. Equity has become volatile and many market players are predicting a further decline from the current market levels.
Debt is generally more secured and provides consistent returns, with a lower volatility as compared to equity. Fixed deposits offered by banks and companies are generally secure too. With the increase in interest rates, they are offering returns up to 10 percent over a two to five year period.
To reduce risk, invest in mutual funds rather than directly investing in shares. Small saving schemes offering attractive returns, safety, convenience, and liquidity are also among the most popular investment avenues. Small savings schemes such as PPF, NSC, Kisan Vikas Patra, Senior Citizen's Savings Scheme, Monthly Income Scheme, Time Deposits, Recurring Deposit Scheme and Post Office SB Accounts, are operated either directly by the government or a government organization (post office or nationalized banks). Most of these small saving schemes are entitled to some tax benefits like income tax, wealth tax, etc, while some schemes even offer a totally tax-free income.
Real estate is another option, which entails heavy capital, with low liquidity, though the investment is safer than some other avenues. However, the procedures of buying and selling are tedious and cannot be done on a regular short-term basis like equity. The returns may be high over a long period of time.
Then there is gold - a traditional avenue. Instead of buying gold, purchase gold exchange-traded funds (ETFs), as they are more liquid and can be traded on the exchanges.
Diversification has the direct effect of reducing the risk taken by an investor. It is to be noted that it does not lower the risk of the underlying securities. Risk is a matter of market trends, economic trends, currency trends, and other factors. There is no way an investor can reduce the risk of securities themselves.
