Diversification of Asset Classes
A basic understanding of the various asset classes which are available for investment helps to
build a lucrative and well-balanced portfolio. A diversified portfolio refers to the grouping of
different asset classes in such a manner so that the overall risk is reduced and portfolio’s
performance is not affected by the inferior performance of any single asset class.
Diversification helps to reduce the non-systematic or firm-related risk of your investment
portfolio by allocating your finances across different asset classes.
It happens when the asset classes in the portfolio are uncorrelated or are negatively
correlated. Correlation between two asset classes shows the direction in which both of them
at any point in time. A negative correlation means that when the price of one asset class falls,
the price of other asset class rises.
Such kind of behavior is observed between equity and fixed income; especially during a market
slump. The main idea behind diversification is to keep the portfolio returns in line with your
expectations and minimize overall losses as much as possible. It educates you about not
putting all your investment in one asset class instead distribute them among multiple asset
The percentage of funds which should go into each asset class deals with the problem of asset
allocation. It means how are you going to distribute a fixed some among all the asset classes in
your portfolio keeping your target rate of return and risk appetite in mind.
Risk appetite is about the quantum of fall in the portfolio value that you will be able to digest
at a given point in time. Based on it, you decide the asset allocation of your portfolio.