Pros and cons of diversified portfolio

In my last post I mentioned that one should have diversified portfolio. However like everything, a diversified portfolio has its own pros and cons. The biggest benefit is resistance in bearish markets. i.e. in bearish markets a diversified portfolio protects you from losses. Just like all stocks do not perform well in bullish markets, all stocks do not fall in bearish markets. Also the extent of rise and fall is not the same. Due to this reason the portfolio is protected by its nature to a large extent. e.g. if you have a diversified portfolio, you might be suffering loss in IT sector, but at the same time those losses might be well balanced by real estate sector stocks. This way your capital will be more secure in a diversified portfolio than a non-diversified one.

You should have a properly diversified portfolio. The diversification strategy further has its own levels of granularities. One broad diversification strategy is as below:

Diversification example

Level 1	Level 2	Level3	Level4
Stocks
	IT
		Infosys
		TCS
		etc etc
	Real estate stocks
		HDIL
		GMR
		etc etc
	Other sectors
Mutual Funds
	General (not sector specific)
		GenMF1
		GenMF2
		etc etc
	Sector specific
		Real Estate MFs
			REMF1
			REMF2
			etc etc
		IT MFs
			ITMF1
			ITMF2
			etc etc
	etc etc
Debt
	Govt Bonds
	Company bonds
	etc etc
Metals
	Gold
	Silver
	etc etc
Real Estate
etc etc

The above diversification strategy is just to serve as an example and is not exhaustive. Besides it may not be practical for everyone to follow depending upon the investment budget.

The example is just to show that there are different levels of diversification depending upon the requirements and budget.

The biggest advantage of diversification as I already mentioned is the resistance to losses in case something goes wrong in one area. e.g. if stock markets are not faring well you might be guarded by your investment in metals or real estate. Also if a particular sector in stock market is not performing well, it might be counterbalanced by other sectors.

However the biggest advantage of the diversified portfolio is also its biggest disadvantage. The portfolio is resistant to shocking losses. At the same time it is resistant to spectacular gains also. It is like an huge elephant - spread so much that it is hard to move in any direction. e.g. during bull run in stock market, the people invested in momentum stocks in a particular stock segment might be getting spectacular returns on their investment. However your returns will be lesser as compared to them, because your portfolio is diversified no only in stock market, but also out of stock market. Also your stock market investments are also not fully in the same stock segment which is moving. The portfolio is spread across segments. Also within the hot segment which is moving spectacularly, your investment is not fully in the stock which is moving fastest. Hope you got the point.

However you should not be discouraged. When it comes to money matters, you should not only think of potential gains, but also protect your money from potential losses. After all it is your hard earned money! The wisdom is to build your profile like an elephant than like a horse... because in long runs horses burn out but elephants keep going on and on....!