Importance of Diversification in Investment and Life

Importance of diversification in investment and life

“Don’t put all your eggs in one basket” is something we have learnt since childhood. What is the real meaning of this old adage? What’s its context in your life? How can it be applied to financial planning? This post tries to emphasize the importance of this proverb, hopefully at the end of which you will change your perspective.

Applicability of diversification to life

Let’s ask ourselves, do we put all our eggs in one basket with life. I think most of us do! Think of the following points:

  1. Career & Profession: Most of us have specialised in one career option and are building on that it. But why? Isn’t that a huge risk? Isn’t that boring? We don’t realise this at the beginning of our careers we end up constraining our life to one type of office, one kind of job in the name of stability. Life is too beautiful to be wasted by limiting our options. For example if you think you are a good writer with some useful thoughts you can start a blog! You probably can learn a new instrument or develop on an existing talent. There are too many hidden pots of gold in you that are waiting to be found.
  2. Health: Again, we all are oriented towards making money! We neglect health. What is wealth without good health? It will be in vain if you only end up chasing money at the cost of all else. If something terrible happens to you, it will be a great deal of suffering for you and your family. So go ahead join a gym and look after your health.
  3. Family: Can’t stress this enough. If you use your house as a bed and breakfast, you need to change that first. Family is what we live for, we can’t see the wood for the trees. Try to spend more time with your partner, mother or whoever it is that loves you the most. Remember the Beatles song — “Money can’t buy you love!”
  4. You: You need some “me” time. Time for introspection, reflection etc. This gets overlooked often, but it’s what helps us progress and enriches our journey of life. Bring sanity to the life you lead and probably give it a whole new meaning.

Now you see, you do put all your eggs in one basket for your happiness. The money basket. Reflect on this, meanwhile we move on to the money basket itself!

Applicability of diversification to investment

“I have all my money in Real Estate”, is probably what you hear from a so called “savvy” investor. Is that a smart approach? In the present scenario, this person probabaly feels jittery as the real estate market is looking extremely weak. So if this person wants some cash jsut now, he/she would have to liquidate the real estate investments at a loss. This does not mean real estate is a bad investment bet; it’s just that it must never be the only investment instrument.

One needs to diversify one’s investment and not put all the eggs in one basket. Broadly I personally believe in four broad categories:

  1. Fixed Income like Fixed Deposits
  2. Real Estate
  3. Equities/Mutual Funds
  4. Gold

We need to have some of each of the above. Question is how much?

The Young & Aspirational

The young and aspirational are between the ages of 18-35. You still have a lot of time left in life and the goals are big. Time is the biggest strength you have as compounding will make your investments yield rich, also responsibilities are relatively low and so are the debts. Therefore the asset allocation should be moderate to high risk and high reward.

 

The Happy Family

This category is the 35+ (<55), and expected to be family of at-least 3 people. Financial needs increase, the ability to take risk reduces and aspirations can soar! This is a period of life with a lot of contradictions. You need more money, but you can’t afford to have risky invetments. If the family belonged to the aspirational young category earlier, the allocations now need to change a bit. This is why the previous category is very important as all the risky investments have already been made. It is sometimes too late later as risk taking ability reduces with thime. Anyway, the family needs to be more conservative and reduce illiquid assets like real estate and land.

 

Happily Retired

From the age of 55 you need to start planning for retirement even if the fire is still burning strong! Remember there are sweeter things in life which retirement offers you a time to chase. So you need to have enough funds at your disposal to tick off that long pending bucket list. At the same time there is no need to be adventurous in investing, as you really need to play safe now. Now is the time to enjoy the view. So get out of all major investments and shift to fixed income. You should ideally be having a sturdy medical insuranceby now. Go for that exotic holiday. Buy that expensive Lazy boy you always wanted. Happy Retirement!

 

Diversification is the key to sustained money flow and happiness. Do spend time in taking stock of your investments and making prudent choices.

Arjun Balakrishnan is an investment fanatic who loves writing about investment topics. He regularly writes at Investment Gyaan.