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Sep 21, 2012, 05.45 PM IST
Investors often invest in a similar asset class which makes their portfolio over or under diversified. This happens because of lack of financial goals. Financial advisor Gaurav Mashruwala enlightens us on the importance of financial goal while building a portfolio.
These are examples of concentrated portfolios. A common investor wouldn't realize the underlying implications here.
If we observe the first instance, we have 10 different equity mutual fund schemes which mean all the money is invested in equity market. Invariably all those schemes would have several scrip which would be similar across those funds.
Similarly in second instance the investment is in a single asset class, which is debt. Performance of each of those bank fixed deposit, corporate fixed deposit, endowment insurance policy, public provident fund account and debt mutual fund will be dependent on movement of interest rate in market place.
In last example of equity mutual fund, direct equity and PMS of equity is a case of investment only in stock market.
While investor might feel he has diversified his portfolio, in reality in all of the above cases there is hardly any kind of diversification across different asset classes.
This behavior pattern is observed in case of an investor who do not have a clear focus of his financial goals. Ideally for long term financial goals which are more than 7/9 years away, we should invest in equity based instruments and for financial goals which are near term - about 2/3 years away - we should choose debt based instrument. For interim goals make combination.
When investors do not have clarity of their financial goals, they randomly start investing in funds. Sometimes they invest large sums of money in fixed deposits. Later they feel, they have over invested in FDs hence may pursue corporate bonds; again later for saving taxes they would park funds in PPF. Since financial goals are not primary focus while investing, when interest rates are rising, they might keep investing in debt based instruments. Similarly when equity markets are rising they might end up parking funds in different kind of instruments which only invest in equity market. All this leads to several different investment instrument, but same asset class and hence there is hardly any kind of diversification.
If above examples show cases investing in different instrument of single asset class, there are also investors who invest small amounts in same instrument. For e.g. people invest in multiple fixed deposit of same company or bank and at times maturing almost at similar times or purchase multiple insurance policy of same scheme e.g. ten insurance polices of same scheme. This is also an example of under diversification.
On the other hand, there are also individuals with Equity portfolio with 40-50 scrip. Some of them will have minuscule amounts. The investor might not even get time to read the balance sheets and corporate announcements of all the scrip. Then we have portfolios with mutilple scrip, multiple fixed deposit, lots of insurance policies, PPF account, and several mutual fund schemes with varied underlying investment philosophy. This is case of over diversification.
Under diversification makes our portfolio risky e.g. all investment, either directly or indirectly in equity or debt as asset class will make our portfolio very risky. On the other hand over diversification increases our paper work, making investment tracking a tough task in itself. Also over diversification doesn't allow to get complete benefit from the upside movement of an asset class.
Therefore be careful while investing. Focus on financial goals and then invest instead or doing it randomly.
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