Portfolio Diversification

Investments

Portfolio diversification spreads investments across different asset classes, geographies, and sectors to reduce the impact of any single investment's poor performance. "Don't put all eggs in one basket" -- diversification reduces unsystematic risk without proportionally reducing returns.

In detail

Types of diversification for Indian investors:n1. Asset class: equity + debt + gold + real estaten2. Geography: Indian equity + international equity (US/global)n3. Market cap: large + mid + small capn4. Sector: no single sector more than 20% of equity portfolion5. Instrument: stocks + mutual funds + ETFsnnDiversification limits: systematic (market-wide) risk cannot be diversified away. 2020 COVID crash hit all equities simultaneously -- diversification within equities did not help.nnOver-diversification: holding 20+ mutual funds is not better than 3-4. Most funds hold similar stocks. 3-4 well-chosen funds (large cap index + mid cap + flexi cap + international) provide sufficient diversification.

Formula

Optimal portfolio theory (Markowitz): minimize portfolio variance = sum of (wi x wj x cov_ij)nPractical: 3-4 non-overlapping funds provide 95%+ of theoretical diversification benefit

Real-life example

🇮🇳 India example

Rajesh: 40% Nifty 50, 20% Nifty Midcap 150, 15% Motilal Oswal Nasdaq 100, 10% Gold (SGB), 15% debt (liquid + short duration). All correlations below 0.6. In 2022 when Indian equity fell 10%: Nasdaq fell 30% but gold rose 8% and debt was stable. Diversification cushioned the blow significantly.

Frequently asked questions

How many mutual funds should I hold? ▼

3-5 funds are sufficient. Core: 1 large cap index fund (Nifty 50/100). Satellite: 1 mid cap fund, 1 flexi cap or value fund, 1 international fund (Nasdaq/S&P 500). Debt: 1 short-duration or liquid fund. That is 5 funds covering all categories. More funds simply creates overlap and complexity without additional diversification.