Diversification remains one of the most effective tools for risk management in an investment portfolio. Experts emphasise that spreading investments across asset classes can enhance returns while mitigating potential losses.

Why diversification matters

Nilesh D Naik, Head of Investment Products at Share.Market (PhonePe Wealth), explains that diversification is akin to building a strong cricket team.

“Just as a good mix of batsmen and bowlers creates a formidable team, a well-diversified portfolio balances different asset classes,” he says.

Each asset class—equities, fixed income, and gold—carries distinct risk-return profiles and responds differently to economic conditions.

This low correlation among asset classes helps manage risk and improves overall portfolio performance.

Balancing risk in a portfolio

Investors should divide their portfolio into two segments.

“The first part should cover short-term financial needs, ideally in low-risk assets like fixed income. The second part, meant for long-term goals, should balance equities, fixed income, and gold based on risk tolerance,” Naik suggests.

He cautions that equities can be highly volatile, with historical downturns of 40-50%, making it essential to determine appropriate exposure based on individual risk capacity.

Hedging against market volatility

Long-term investors can best navigate volatility through diversification.

“Spreading investments across asset classes, geographies, securities, and time through systematic investments is key,” Naik advises.

Having the right mix aligned with risk tolerance helps investors stay disciplined and avoid emotional decision-making during market fluctuations.

He stresses that market volatility is inherent to equities and should be accepted rather than feared.

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International diversification still relevant

Despite increased global market correlations, international diversification remains valuable.

“The correlation between Indian and US equities has been in the range of 0.5 to 0.6 across different periods. While positively correlated, this level still offers meaningful diversification benefits,” Naik points out.

Allocating a portion of investments internationally can enhance risk-adjusted returns.

Avoiding emotional investment decisions

A clear asset allocation framework helps investors avoid impulsive reactions to market turbulence.

“Decisions should be based on investment objectives, time horizon, and risk tolerance rather than short-term market movements,” says Naik.

Investors can also use relative valuation measures to guide tactical changes while adhering to their long-term strategy.

He warns that many investors neglect asset allocation principles during bull markets, only realising their importance when markets correct.

Ultimately, maintaining a disciplined investment approach and diversifying across asset classes can help investors navigate volatility while optimising long-term gains.

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