Why should you diversify your portfolio globally?
We all are aware of the benefits of diversification and all of us try and maximize the returns and reduce the risk by maintaining a good mix of stocks, mutual funds, gold, real estate, fixed income and getting it managed professionally.
Talking of global investments, one might argue or question whether it is really required. We are a developing economy, growing at a fast pace. And when there are so many areas to invest across diverse sectors in our country, why look at investing outside your own country just to diversify a bit more? After all, understanding the global markets, evaluating the investment options, the regulatory laws with respect to investments, keeping in mind the currency fluctuations and the tax laws-it is not easy.
What happens if you put all your eggs in one basket
“Don’t put all your eggs in one basket”
This is an old proverb which has been used over the years in all contexts including investments. Its applicability to your investments is not just about diversifying your portfolio by investing in various asset classes. What is more significant is the fact that these asset classes are not perfectly positively co-related to each other and their volatility and returns are driven by different market factors.
To understand this better let us consider the four main asset classes an investor usually invests in-
Equity, Debt, Gold and Real Estate
Equity and Gold – They are known to be negatively co-related to each other. During the secular downtrend in equity markets during the period 2007 – 2009, most equity investors lost money on their equity investments but gold prices went up significantly. Hence an investor with an exposure to both equity and gold in this period would have fared much better than someone who invested only in equity.
Equity and Debt – Though in the long run an equity market’s growth represents the country’s economic growth, they tend to be volatile in the short term, while debt markets even out this risk with their steady and consistent returns. Historically there have been periods where equity and debt have had an inverse relationship. When the dotcom bubble burst and the stock markets hit an all time low in 2000-2001,interest rates in India were on the higher side – in the range of 11%-13 % p.a.
Real Estate – Real estate has a very low co-relation with stocks and hence is an important avenue for diversification after the required exposure to stocks. Real estate has an inverse relationship with interest rates. Low interest rates in the economy boosts real estate investments. Hence during such periods, an investor who is mainly exposed to debt may not be able to beat inflation, but an investor who has invested in both will witness a rise in the value of his real estate investments which will compensate for his low yielding debt portfolio.
Hence not putting all your eggs in one basket and prudently distributing your investments among these asset classes ensures that whatever be the economic scenario, you will never end up with a situation of all your investments performing poorly.