Is Diversification Overrated? Things You Need To Know About Diversification and Its Measurement

Many investors, including some famous ones, have expressed that diversification is not ideal for investment. It can kill your money

Shocked?

Yes, some investors believe in this ideology.

Recently, I was studying one very highly rated investor's opinion on Diversification. While I admire the investor for his honest and brutal opinion, I believe that in finance, a few things and philosophies are primarily based on assumptions and are subjective.

But what is this diversification that I am talking about?

It is one of the key strategies for managing risk and potentially maximizing returns in an investment portfolio. It spreads the risk of investing in any particular asset or sector, and this cross-concentration is beneficial during market uncertainties.

Here is what you can do to diversify your portfolio.

1. Various asset classes: You can start by investing in various asset classes. A well-diversified portfolio generally includes different asset classes, such as stocks, bonds, and cash. The portfolio's overall performance is potentially improved when you spread out the risk of investing in any particular asset.
2. Different sectors: An asset class is also comprehensive regarding options for investing. So a sub-diversification within each asset class is essential. You can consider investing in various sectors to diversify your portfolio further. For example, if you are investing in stocks, consider companies in different industries such as Pharma, Banking, and Technology.
3. Global Exposure: The dollar value in 2010 was approximately Rs 45, while its value now is Rs 82. If you had invested in US stocks back then, you would have also got currency appreciation apart from stock price appreciation. So, consider adding international investments to your portfolio instead of just investing in domestic companies. This can provide exposure to different economies and potentially provide additional diversification benefits.
4. Low-Cost Index Funds: Index funds have been trending on Youtube because of their obvious benefits. They are low-cost funds, and you can invest in always top-performing companies through such funds. It is an excellent choice for passive investment.
5. Portfolio rebalance: As the value of your investment changes over time, rebalancing ensures that your portfolio does not get concentrated over a long period. This may involve selling some investments and purchasing others to bring your portfolio back to your desired asset allocation. Here is one example of the rebalancing that I follow

To be honest, diversification does not guarantee a profit or protect against loss. However, we can try to make our portfolio rock solid to some extent. Therefore measuring diversification is beneficial.

The measure of diversification is crucial when it comes to applying it. There are various ways to measure it in an investment portfolio. A commonly used approach is "Standard Deviation." It is a measure of the volatility or risk of an investment.

The lower the standard deviation, the less volatile the investment is considered to be.

For example, consider that your portfolio has two investments: Investment X and Investment Y. Investment X has a standard deviation of 10%, while Investment Y has a standard deviation of 20%. If these two investments are combined in a portfolio, the overall portfolio standard deviation would be lower than either of the individual investments.

The degree to which the portfolio's standard deviation is lower than the individual investments is known as the "diversification effect." The higher the diversification effect, the more diversified the portfolio is considered to be.

That's it for today. Let me know in the comments if you want me to write on any specific finance topic.

Disclaimer:        

This article is about personal investment philosophy and a medium to generate awareness in the financial journey. None of the content, in part or whole, articulated here is any financial advice. Please consult your financial advisor before making any financial decision.

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