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Stockmarkets: Play it safe!

Dec 6, 2005

As the Indian markets chug along a volatile path in their quest for a 'greater glory', the small investor has been left with nothing but little luck and hordes of advice from 'experts' who predict even better times ahead (as they project the BSE-Sensex to breach the 10,000 levels!). 10,000 or no 10,000, investors need to understand that even at the current levels, the risk-reward ratio is highly skewed towards the former, until and unless one is ready to play a really long-term strategy to investing. In this very context of risk-reward analysis, there stands a concept of 'diversification', or avoiding putting 'all eggs in one basket'. Diversification of an equity portfolio involves dividing investible funds across various sectors and stocks, with the primary objective being - getting 'optimum' (not maximum) returns with minimal risk. Diversifying the portfolio can mitigate unsystematic risks - those that are specific to a sector/company. Systematic risks, on the other hand, are associated with all the companies/sectors and can hence not be mitigated through diversification.

However, investors need to take note of the fact that diversification does not mean investing in 'any' and 'many' stocks. With 'any' stock we mean that the fundamentals of the company should not be compromised with. Further, 'many' stocks indicate that an investor should limit the number of stocks in his portfolio rather than having everything that looks to good to him. The reason for this is obvious - difficulty in keeping a track of all the stocks in the portfolio.

Also, an investor needs to properly plan his diversification strategy. While planning the same, time horizon (i.e., period for which the investment is being made) and the risk appetite (capacity to bear risk which is dependant on age, financial position and future needs of the investor) should be considered. Once the risk bearing capacity is decided, the investor must select stocks that would yield him optimum returns. This apart, while picking stocks, an investor needs to also ensure that the stocks selected are not highly correlated. Thus, diversification should not only be within the sector but also across sectors.

Although investing in a particular stock and reaping high returns sounds as a lucrative and exciting proposition, it is very difficult to put it in practice and succeed time and again. Thus, diversify! And play it really safe!


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