Investing in the stock market in India for the long term is a great way to create wealth. However, given the high degree of risks associated with the stock market in India, the investor needs to follow some basic rules.
Today let's take a look at the importance of adequate diversification, one of the most basic but essential rules which every investor should follow while investing in the share market in India.
Remember Kodak, the company which once used to be the no.1 producer of still cameras and films for it? The famous "Kodak moment" television and print media advertisements which promised to capture the special moments in our lives on photo forever?
With the advent of digital photography, Kodak saw a massive decline and ended up filing for bankruptcy in 2012. Kodak's main competitor, Fuji film, however, survived the onslaught of digital photography and emerged victoriously.
Do you know why? Fujifilm survived and became successful because of diversification. Unlike Kodak, Fujifilm recognized early that photography film was a finished business and hence aggressively diversified into a wide range of products and targeted new markets.
In any line of business, diversification is the key to success. Forget businesses; diversification is something which we all do in our day to day life too. In simple things such as our daily diet.
Now, most of us know the importance of eating a balanced diet? It is nothing but diversification. Why? Because a well-balanced diet comprising of proteins, carbohydrates and healthy fats gives us the energy and the nutrients required by our body for growth and repair and helps us to stay active and healthy.
As an investor, it is crucial to diversify your portfolio. "Don't put all your eggs in one basket" is one of the most relevant quotes by none other than one of the most successful investor in the share market, Warren Buffett.
Now when someone of Warren Buffett's stature gives a piece of advice, it is something which every investor aspiring to be successful in the share market in India or anywhere in the world should take seriously.
Importance of diversification while investing in the share market in India
When you invest in stocks of multiple companies in the share market, you can be sure that even if some underperform, you can successfully ride the wave on others. Optimum diversification in stocks can be achieved by buying different shares, in various sectors which are not related. This way, a fall or underperformance in one industry doesn't usually hurt another.
In his book, The Intelligent Investor, legendary Benjamin Graham has recommended investing in 10 to 30 stocks for adequate diversification. In the context of Indian markets, experts suggest that a portfolio of about 15-20 stocks offers optimum diversification. Anything beyond this would result in an over-diversified portfolio. Click here to read more about perils of over-diversification.
The whole point of adequate diversification, while investing in the share market in India is that you might be better off owning the 15-20 best-performing stocks in your portfolio from multiple sectors. On the other hand, when you own 15-20 stocks of the best stocks as well as 25-30 non-optimal stocks, their non-performance will pull down your overall portfolio performance. In other words, the increased benefits from owning 25-30 additional shares would be small compared to the expected loss of return.
Click here to know more about creating a high-performance portfolio of 10 to 20 stocks.