When investing it is always common to hear people talking about ‘diversification’, and it is only fair to do that. A sound financial expert or a rookie investor beginning their investment journey; both know about this concept and are eager to apply it too. Let us take a glance at both of their strategies:
The Financial expert: Invests in securities from different asset classes or securities of the same asset class spread over different companies.
The rookie investor: Invests through 2 stockbrokers, 2 mutual fund distributors, and 1 bank.
While at the first glance both of these might look diversified, they are very different concepts. Let us understand how and why?
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What is Deworsification
Let us try and understand what is deworsification by an example:
You have decided to cook today. You have the recipe, ingredients, pots, and pans everything ready. You add all the ingredients, leaving out salt and chili to add at the end. You go out of the kitchen and your sibling comes to the kitchen; tasting the dish they feel its lacking something. They decide to help you and add the salt and some spice. They leave and you come, unaware of what had happened earlier you add more salt and more spice to the dish.
The resultant final dish is thus ruined.
It’s the classic situation of too many cooks spoiling the broth, well the same principle applies to the concept of deworsification. Where too many; brokers and securities may spoil the risk-reward ratio of the whole portfolio and thereby create a mess, that can’t be undone.
The strategy that the rookie investor undertakes is one of the prime examples of ‘deworsification’. It can primarily imply distributing your money across multiple individuals. The primary disadvantage of deworsification is that the portfolio takes over more risks than the rewards can offset.
While diversification aims at distributing the risks and bringing down the overall risk factor in the portfolio, but “deworsification” would result in a confusing portfolio. To have a well-built portfolio, that negates risks and provides returns that help in wealth creation, investors should know the difference between diversification and deworsification.
Major signs of a deworsified portfolio
- Too many people involved:
If you have more than one professional involved in handling your investments, chances might be that the portfolio isn’t diverse it is deworse.
- Too many securities involved:
If in your portfolio there are securities of the same asset class in large numbers, for example having 30 mutual funds Schemes, the chances are high that your portfolio isn’t diverse, but deworse.
The Trust Factor
One of the main reasons for which investors indulge in diversifying the wrong way is the lack of trust. When it comes to money people are wary of whom they should place their trust, so to hedge on trust, investors undertake the mistake of placing their money in various hands. Not only will this increase the risk factor of the portfolio, but it will also lead to extra costs.
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How to overcome this:
While there is no definitive solution to the problem of trust, there are mitigation measures available at the disposal of the investor.
- Take in a second opinion:
While it is advisable to take the advice of a sound financial expert when going forward in your investment journey, it isn’t harmful to listen to a second opinion. This implies that careful research on part of the investor in choosing the right financial advisor will ensure that the right steps are taken towards effective portfolio construction as per your goals and needs.
- Choose the professional help after careful consideration:
As mentioned in the previous point, research and choose the right professional for your investment journey. Look at their past records, see testimonials, figure out if they offer services that match your goals in investing, and then make the final call. Removing the confusion around this part will save a lot of time and resources for later.
- Have a definitive goal with your investment:
While beginning to construct a diversified portfolio or taking professionals to help while doing so, you should be aware of the end goals that you wish to achieve. This will in turn help in defining the portfolio according to your specific goal set.
- Review your investment plan and strategy:
Regular reviewing of the investment plans and strategy will help you keep you understand if or not your portfolio needs any alteration.
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“Don’t put all your eggs in one basket”, is the basic principle that functions around diversification. It ensures that you don’t face absolute risk by parking your funds in just one security. Diversification is a solid concept towards effective portfolio creation but still it should be undertaken with caution. Make sure that you don’t overdo to remain extra cautious, as you now know that there are clear downsides to it.
Do your research well, plan your goals, assess the required professional help wisely and you will be well on your way to a Happy Diversification!
(Saarthi for your dreams)