Every day in everything that you do, you have a variety of options to choose from, be it selecting what to eat for lunch, or what clothes to wear.? But you don’t select the same lunch or the same clothes every time, do you?? Similarly, when it comes to investing, there are many options available. It’s important that you can figure out which to choose as selecting the same option will not work every time.? By diversifying your selection, you can build a smoother portfolio which can help meet all of your requirements in changing market conditions.? Say you purchase shares in a real estate company.? Your friend decides that in addition to the same real estate stock, she will also purchase some bonds. One day, the government announces a policy that negatively impacts the real estate market and your shares fall in value. ? Both you and your friend lose money, but your friend may not feel as bad as she has other assets in her portfolio which can help offset the fall in the share price.? Then, a few days later, interest rates are cut, causing bond prices to rise. Now the value of your friend’s portfolio goes up as the value of her bonds increase, but your portfolio stays flat.? So what did she do right?? She diversified her portfolio across asset classes.? She ensured that she bought a good mix of assets which helped her withstand the volatility of the market. Even if one portion of her portfolio went down, the rest did not, helping her to maximize return while lowering risk.? The reasons why diversification works are very clear.? Returns for different asset classes may vary at the same time.? For example, the price of stocks and bonds generally don’t move in the same direction.? Different factors affect the performance of different investments, but not all of the factors can be predicted.? So when you diversify your portfolio by holding different investments and asset classes, you reduce the risk of losing money compared holding a single investment. Building a portfolio of investments across different asset classes will help you better withstand the unexpected blows that the markets tend to give now and then. This is why experts advise that a well-diversified portfolio can help you manage your level of risk and deliver better results for your portfolio over the long term.? However, you have to be careful in how you achieve diversification. Having too much – or too little - of any one asset can expose you to greater investment risk and can affect your portfolio return.? One easy way for you to achieve diversification is to invest in mutual funds.? Mutual funds offer the built-in advantage of giving you exposure to a combination of different investments, both within and across asset classes, along with the expertise of experienced fund managers constantly reviewing the portfolio and maintaining the right balance.? You can consult your investment adviser to learn more about the types of mutual funds that are suitable for you.? Remember, when it comes to investing, as in life, don’t put all your eggs in one basket. Most good habits are learned best when you start early.? It’s the same with investing; the earlier you start, the better the outcome will be for you. One of the main reasons for this is the power of compounding - the process of generating earnings from previous earnings. By remaining focused, reinvesting your earnings and having a long term, investment horizon, you will be able to achieve higher levels of returns. And the more time you give to your investment to compound, the more wealth you will create for yourself.? Let’s consider an example, suppose you and your friend want to invest $60000 over a period of 10 years, but you both do it at a slightly different time frame.? While you decide to invest $500 monthly beginning from Day 1, your friend starts investing in only the sixth year at $1000 monthly.? Let’s say you both earn 10% return annually, how do you think the investments will pan out?? Even though you both invested the same amount of money over the course of 10 years, at the end of the 10th year, your investment would have grown to more than $100,000? while your friend’s investment would only amount to around $77,000.? By starting early, you accumulated significantly more wealth than your friend. ? And by giving your investment more time to grow, the returns you earned in the early years help increase your capital and therefore earn you more returns.? This is why it’s best to start investing early, and to reinvest your returns to maximize the earning potentials of your investment using the power of compounding.? The first step in successful financial planning is to understand what you are investing to achieve.? Your financial goals should ideally determine how much money you need to invest.? As a general rule, keep six months of expenses saved in your bank account to deal with any emergencies and to fulfill your short-term needs, such as taking a holiday.? To meet your long-term financial goals such as buying a home, planning for your children’s education, retirement, etc., you need to invest smartly and for a longer duration.? In order to figure out how much to invest, realistically estimate how much your goals will cost you in the future, keeping inflation in mind.? Now calculate how much you need to invest each month to get to that amount considering your risk appetite, investment options, and time horizon.? Even if you start by investing a small amount, you are at least taking the first step towards fulfilling your financial goals.? However, make your investments wisely after studying various investment options.? Remember, you can always visit a financial adviser to help you understand how you should be investing to achieve your financial goals.
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