Why You Shouldn’t Invest In Equities Alone And Look At Diversification

Investing all your money in equities can cause deep losses in the short run as the asset class is volatile.
Why You Shouldn’t Invest In Equities Alone And Look At Diversification

Recently, a young investor, who is a member of Facebook group Asan Ideas For Wealth, sought advice on his future course of action on equity investing as he lost about Rs 1 lakh in a year.

“Biggest risk of my life! Started investing into equity in 2021 and within a year lost 1L. Should I wait to see some good results in the future or it's a red flag! Please help suggesting,” he posted on Facebook.

Usually, experts would say that his portfolio may have suffered because he put all his eggs in one basket—equity—but the investor argued in the comments section that he had diversified his investments. While he indeed diversified within equity by investing in various categories of equity mutual funds and bought direct stocks too, what he perhaps didn’t realise that he had not distributed his money between different asset classes such as debt, gold and others.

Over the past year, many young investors reportedly entered the equity market for the first time. One of the mistakes they made was investing in equities alone. Here’s why investors need to look beyond just one asset class and diversify their portfolios.

According to Rajiv Shastri, director and CEO at NJ AMC, "When different schemes hold the same stocks, the diversification targeted by an investor is compromised. Even though investors may feel that they have diversified by investing in different schemes, if these schemes invest in the same stocks then genuine diversification isn't really achieved."

Look Beyond Equities

Rusabh Desai, founder, Rupee with Rushabh Investment Services, says that young investors who have just started investing in the market should understand that equities as an asset class are highly volatile and there is a need to diversify. “Investments apart from only in equity funds will help them in reducing their concentration and volatility risk and allow them a separate passive income stream and peace of mind," says Desai.

Diversifying investments might help many new equity investors compensate for the loss suffered in equity markets to a certain extent.

Ankit Gupta, founder, BondsIndia.com, says that the recent equity market correction caused deep losses to many investors. However, the fact is that equities are long-term instruments and can be highly volatile in the short term.

If one needs money in the short term, one may consider investments in assets such as short-term bonds. “Bonds are known to provide stable and steady returns. It is preferred for its fixed income feature and return of principal on maturity. Moreover, investors can choose to invest in short-term or long-term alternate investment instruments based on different personal or professional financial goals. Choosing to invest in short-term bonds like government bonds, Reserve Bank’s Treasury bills, etc. and diversifying investments might help many new equity investors compensate for the loss suffered in equity markets to a certain extent,” he added.

How Does Diversification Help?

Diversification helps as gains in one asset class can balance the downside in another. “To protect our investment from a downside, it's imperative for any investor to diversify investments across asset classes, namely equities, fixed income instruments, gold, real estate, and others. This spread of investments can counter the downturn that comes about periodically, manage the portfolio from being vulnerable to external conditions, and deliver better average return,” says Gopal Kavalireddi, head of research, FYERS Securities.

Swapnil Kenhe, a Sebi-registered fee-only investment advisor (IA), says, “Diversification across asset classes protects you from unlucky outcomes in an asset class you would otherwise be over-concentrated in. You don't also miss out if there are lucky outcomes. Diversification reduces the role luck plays in investment outcomes to some extent,” Kenhe adds.

Kavalireddi suggests that besides diversifying among asset classes, one should diversify across geographies too. “Each country has its own monetary and fiscal policies, decided and implemented by respective central banks and governments. With macro and micro factors impacting each country differently, an equi-weighted spread of assets across countries can minimise the risk and create a consistent return profile over longer periods,” he says.

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