Suppose you have just invested a significant amount of your hard-earned money in an equity mutual fund that you believe will generate great returns. You have done your research and studied the market to identify the promising stock to buy. You sit back and wait, eagerly anticipating the growth of your investment. But what happens when the market takes a downturn, or one of those companies fails? Suddenly, all your investments are at risk, and you may face substantial losses. This is where diversification becomes important.
If you are looking for ways to maximise your investment potential and protect yourself from financial loss, read on to learn more about why diversification should be part of your investing strategy.
Weathering market volatility
Diversifying your equity fund gives you the ability to weather market volatility better than if you were invested in just one asset class or sector. When markets start to decline or experience volatility due to events such as political unrest or economic uncertainty, having a diverse portfolio can help protect your investments since not all sectors are affected equally by these events.
Additionally, when markets rebound again after a period of volatility, having a diverse portfolio will give you more opportunities for growth since some sectors may outperform others during periods of economic growth and expansion.
When you invest in a single stock or asset, you are putting all your eggs in one basket. This means that if the company goes bankrupt or the value of the stock drops significantly, your investment may be at risk.
For instance, if you had invested all your money in the hotel or airline sector, the COVID-19 pandemic would have significantly impacted your investment’s value. But with a diversified portfolio, you would have held several other companies and sectors that remained unaffected, minimising the overall impact and mitigating the risk.
Diversifying your equity funds can also provide tax benefits since some investments may be eligible for deductions depending on their structure.
For example, ELSS (equity-linked savings scheme) is a type of equity fund that allows investors to save tax under section 80C of the income tax act. Apart from being an excellent tax-saving tool, investing in ELSS also offers diversification benefits by investing across different market capitalisations ranging from small cap to large cap and various sectors, which helps reduce risk and maximise returns.
How to diversify equity investments without investing lump sums or timing the market?
Stock market can be unpredictable and volatile, making it difficult to know when it’s best to buy or sell a particular investment. One way to easily incorporate diversification into your equity fund investments is through a systematic investment plan (SIP).
An SIP allows you to make small and regular investments in a mutual fund scheme. This way, you don’t have to make large lump sum investments but still benefit from the advantages of diversification by spreading out your investments with every new SIP instalment. Moreover, SIP gives you the ability to adjust your purchasing power in response to market fluctuations by leveraging rupee cost averaging.
Be sure to use an online SIP calculator so you can compare different SIP plans along with their returns beforehand. It can help you determine how much you should invest in equity funds each month depending on your age, income level, investment goals, and timeline! This can help you understand your investment growth better and facilitate strategic planning.