4 Diversification Secrets the Wealthy Use to Protect Their Money

In Short:

• Diversification is an investment risk management strategy that spreads your money across different assets to reduce volatility

• The four key diversification strategies include spreading investments across asset classes, within asset classes, geographically, and over time

• Many investors either over-diversify (diluting returns) or under-diversify (taking on excessive risk)

• Simple tools like SIPs, index funds, and ETFs make diversification accessible even for beginners

• Regular portfolio rebalancing is essential to maintain your desired risk level

  
  

The Safety Net of Smart Investing

As I was having Tea with a friend last Diwali, he proudly told me about investing his life savings in a "guaranteed" cryptocurrency scheme. Six months later, the platform shut down, and he lost everything. This story highlights what happens when we ignore one of investing's golden rules: diversification.

Diversification is simply the investment equivalent of not putting all your eggs in one basket. It's a risk management strategy that spreads your money across different investments to reduce the impact of any single investment performing poorly.

Imagine walking a tightrope – would you rather do it with or without a safety net? Diversification is that safety net.

As Tony Robbins explains in his exceptional book "Unshakeable," diversification is one of the fundamental principles that can help you weather any financial storm. Today's article draws inspiration from Robbins' insights while adapting them to our Indian investment landscape.

Why Diversification Matters

In 2008, when global markets crashed, investors who had all their money in stocks lost around 50% of their wealth. Meanwhile, those with diversified portfolios including bonds, gold, and other assets experienced much smaller losses.

Warren Buffett once said, "Risk comes from not knowing what you're doing." Diversification helps manage risk even when we don't have perfect information (which is always).

Consider this: The BSE Sensex has delivered an average annual return of approximately 15% over the long term. But this average includes years like 2008 (-52.4%) and 2009 (+81%). Without diversification, these swings can be emotionally devastating and financially ruinous.

Now, let's explore the four diversification strategies that can transform your investing journey.

Strategy 1: Diversify Across Asset Classes

Asset classes are categories of investments with different characteristics and behaviours. The main ones include:

• Equities (Stocks): Ownership in companies, higher risk, higher potential returns

• Fixed Income (Bonds): Loans to governments or companies, more stable, lower returns

• Real Estate: Property investments, provides rental income and appreciation

• Cash: Money in savings accounts or liquid funds

Think of these asset classes as members of a musical band. When one is having an off day, the others can pick up the slack.

For example, when COVID-19 hit in March 2020, the Indian stock market crashed almost 40%. But gold prices rose 25% that year, and government bonds performed well too. Investors with money spread across these assets felt much less pain.

A simple way to start is with a mix of equity and fixed income. For my 32-year-old cousin starting her investment journey, I recommended 65-70% in equity mutual funds and 30-35% in fixed deposits and debt funds. As she gets older, we'll gradually increase the fixed-income portion to reduce risk.

Strategy 2: Diversify Within Asset Classes

It's not enough to just own stocks – you need to own different types of stocks.

Let me share a personal story. When I started investing, I put most of my money in banking stocks because that sector was booming. In 2018, when banking faced regulatory challenges, my portfolio took a massive hit. I learned my lesson the hard way.

Within equities, you should diversify across:

• Market capitalizations: Large-cap, mid-cap, and small-cap companies

• Sectors: IT, banking, pharmaceuticals, consumer goods, etc.

• Investment styles: Growth, value, dividend-focused

For the average investor, mutual funds and ETFs (Exchange Traded Funds) are excellent tools to achieve this diversification. Instead of picking individual stocks, a simple Nifty 50 index fund gives you exposure to India's 50 largest companies across various sectors.

By diversifying within asset classes, you're essentially serving your future self better by reducing unnecessary risks.

Strategy 3: Diversify Geographically

In 2022, while the Indian market struggled with inflation and geopolitical tensions, certain international markets performed differently. This highlights why geographical diversification matters.

When you invest only in Indian companies, you're exposed to India-specific risks like local policies, currency fluctuations, and economic conditions. By adding international investments, you reduce these country-specific risks.

Think about it: If you could have invested in both Apple and Infosys over the last decade, wouldn't you have wanted exposure to both growth stories?

For Indian investors, there are several ways to gain international exposure:

• International mutual funds offered by Indian AMCs

• ETFs that track global indices

• Direct stock purchase from apps such as INDMoney

  
  

Strategy 4: Diversify Across Time (Dollar-Cost Averaging)

Timing the market is nearly impossible. Even the smartest investors can't consistently predict market tops and bottoms.

This is where Systematic Investment Plans (SIPs) shine. By investing a fixed amount regularly, you buy more units when prices are low and fewer when prices are high, automatically lowering your average purchase price.

Consider an investor, who invested ₹10,000 monthly in an equity fund through SIP for the last five years. During market dips, his ₹10,000 bought more units, and during highs, it bought fewer. This approach removed the emotional aspect of investing and the stress of timing the market.

This time diversification strategy works because it:

• Enforces investing discipline

• Reduces the impact of volatility

• Eliminates the pressure of making perfect timing decisions

Tony Robbins emphasizes this in "Unshakeable," noting that regular investing through market cycles is one of the most reliable paths to long-term wealth.

Common Mistakes to Avoid

Over-Diversification

Owning 30 mutual funds doesn't make you more diversified if they all invest in the same types of companies. It only increases complexity and costs. As my grandfather would say, "Too many cooks spoil the broth."

Under-Diversification

The most common mistake I see among my readers is having 90% of their investments in just fixed deposits or just 2-3 stocks. This exposes them to unnecessary concentration risk.

Confusing Variety with Diversification

Owning five different bank stocks isn't true diversification. It's like having five different umbrellas when what you really need is an umbrella, a raincoat, and waterproof shoes.

Ignoring Costs

Some investors add expensive products to diversify without considering whether the benefits outweigh the costs. Remember, every percentage point paid in fees reduces your long-term returns significantly.

Practical Steps to Get Started

1. Start with asset allocation: Determine what percentage of your portfolio should be in equities, fixed income, and other assets based on your age, goals, and risk tolerance.

2. Use simple tools:

   • Index funds for broad market exposure

   • SIPs for disciplined investing

   • ETFs for sector-specific or international exposure

3. Keep costs low: Favor passive funds with lower expense ratios for the core of your portfolio.

4. Rebalance regularly: Once a year, adjust your portfolio back to your target allocation. This automatically enforces the discipline of buying low and selling high.

5. Start small but start now: Even ₹1,000 per month in a diversified SIP is better than waiting to accumulate a large sum.

The Unshakeable Path Forward

In "Unshakeable," Tony Robbins reminds us that "The path to financial freedom is not paved with complex investments but with simple, time-tested principles consistently applied."

Diversification isn't about eliminating risk—it's about managing it intelligently. It won't necessarily maximize your returns in any single year, but it will help you stay in the game long enough to let the magic of compounding work for you.

As you build your diversified portfolio, remember this quote from Robbins that I've found profoundly true: "It's not what we do once in a while that shapes our lives, but what we do consistently."

Start building your diversified portfolio today, stay consistent, and watch as your financial future becomes increasingly unshakeable.