Don’t put all your eggs in one basket.
It’s age-old advice and as far as investing money in 2022 is concerned, it’s still applicable. In fact, if recent events have taught us anything, it’s that one must diversify their investments across different asset classes.
What makes investment diversification such a great strategy? How can you diversify beyond mutual funds? How do you decide where you should invest?
We’ll answer all those questions in the upcoming sections. But before that, let’s start with a simpler one.
What is investment diversification?
Simply put, investment diversification is a strategy that dictates investors should put their money in a variety of investment instruments and assets. The supporting argument to this advice is that the practice of diversification prevents investors from being overexposed to a small number of assets. Ideally, an investor should stay diversified across assets and asset classes.
Now, let’s find out what makes diversification such a highly recommended strategy for smart investors.
Advantages of investment diversification
Investment portfolio diversification offers investors a variety of advantages:
More Opportunities For Profit
Being diversified when the economy is experiencing fast-paced growth can feel like a pain. However, it is easy to forget the bad times during bull runs. Don’t get this wrong; a portfolio can be conservative or aggressive and still be diversified. Imagine having multiple winners in your portfolio.
Diversification also makes a lot of sense from the probability point of view. When you are invested in a larger number of assets, you are more likely to find yourself invested in a winner. With a concentrated portfolio, however, you only have a few guesses to find a winning asset.
Effective Risk Aversion
How diversification reduces an investor’s risk exposure is not difficult to imagine. By being exposed to a larger number of assets, even if one asset starts losing value, there’s a chance that your other investments will perform well, and you can recover the loss. Even if you are unable to recover the loss, a small percentage of your portfolio value will be lost.
On the other hand, if an investor is exposed to only a handful of assets, and one of them starts losing value, things can become very intense very quickly. The reason is The Math Of Gains And Losses. Without getting too technical, the maths dictates that to make up for a loss of 5%, you will need to make more than 5% profit. Here’s the worst part- this effect is compounded.
That means, to make up for a loss of 10%, you will need an 11.1% gain. However, to make up for a 20% loss, you will need to make a 25% gain. A 300% gain will make up for a 75% loss.
It is true that this scary scenario is true for both concentrated and diversified portfolios. However, with the latter, a loss in one asset may amount to a small percentage of your overall diversified portfolio. That’s what makes diversification a superb low-risk investment strategy.
Moreover, it is important to remember that diversification pays off really well when the markets are down. In fact, diversifying into assets and investment opportunities that aren’t market-linked is a superb way to reduce the risk exposure of your portfolio.
Here’s a great way to do that:
Diversify Into A Market-Independent Investment Opportunity
The most effective way to safeguard your investment portfolio from the volatility of markets is to invest outside the market. However, with the inflation hitting 6%+, formerly popular options like fixed deposits have lost their charm. Most other types of non-market linked investment opportunities have either the same problem of low returns or are simply not accessible to the average investor.
An alternative is peer-to-peer or P2P lending. It’s market independent, and on a platform like LenDenClub, most investors have made an average of 10 to 12%* annual returns on their investments.
Having said that, just because the risk isn’t market-linked, that doesn’t mean there is absolutely no risk involved with P2P lending as an investment instrument. Like almost every other investment opportunity, there is some degree of risk involved.
Let’s begin by quickly understanding how a P2P lending platform works. LenDenClub is like a marketplace where lenders (investors that want to lend their money at a interest rate) and creditworthy borrowers can connect. The lending happens between the two directly, using an escrow mechanism. This helps eliminate the middleman while protecting the privacy of both the lender and the borrower.
The lender benefits from the interest rates, which translate to superb returns, while the borrower enjoys easy access to credit.
By now, you may have realised what kind of risk this arrangement poses for the investor- the risk of default.
Fortunately, diversification can help mitigate this risk. Moreover, the platform has strong credit check policies and screening mechanisms to ensure creditworthy borrowers are listed on the platform. There is also a strong collection mechanism in place to recover loans in case of defaults. Find out more about this here
How LDC Diversifies Investments Among Different Borrowers
Remember, one should diversify across asset classes and different assets within those asset classes. On LenDenClub, you can do exactly that to reduce your risk exposure.
Instead of loaning a large amount to a single borrower, you lend small amounts to multiple borrowers. This way, even if one of the borrowers in your portfolio defaults, your exposure to risk is limited. On LenDenClub, you can invest as little as INR 500 with a single borrower.
The best part is, you can make automated investments on the platform. An AI-powered investment tool will seek out borrower profiles that match your defined criteria and automatically invest your money with them in small chunks.
Remaining diversified is a superb and sustainable investment strategy. In the long term, it can drive incredible returns and offer investors impressive protection against risk during that time. Observing the current volatility of economies across the globe, investors must look for investment opportunities outside the scope of the stock market, and in that regard, P2P lending is definitely worth exploring. Start your diversification journey by investing in this low-risk opportunity only on a certified NPBC-P2P platform like LenDenClub. Click here
*On platform level