Most investors start their investment journey with a simple thought: “To stay safe, I need to diversify.”
This instinct is not misplaced — diversification is indeed a powerful principle. However, in practice, many investors unknowingly adopt approaches that appear diversified but fail to receive the true benefits of diversification.
In the sections that follow, let’s examine this issue more systematically, understand what’s actually happening inside portfolios, and then explore the simple yet effective solution that often gets overlooked.
1. When diversification becomes over-diversification
Many investors begin with a familiar thought: “I want to be diversified, so I’ll own a little bit of everything.”
What often happens is a gradual accumulation of various equity funds, thematic / sectoral funds, with overlapping positions. Most investors end up holding a bit of everything – multiple styles, themes, and sectors – rather than sticking to a few carefully selected funds or a clear allocation strategy.
It’s not uncommon to see portfolios with 20+ equity funds and 60-80 stocks stacked on top of each other. At first glance, it may seem diversified and sophisticated…
But here’s the catch: Past a certain point, adding more holdings doesn’t reduce risk – it simply reduces impact.
Let’s put some numbers to this. Imagine you have a portfolio of 60 stocks, each equally weighted at roughly 1.67% of your portfolio. Now, suppose three of these stocks triple in value over a year.
- Individually, that’s a 200% gain per stock.
- But each stock represents only 1.67% of your portfolio, so their contribution to the overall portfolio is roughly 5% for 3 stocks.
So even though you had some spectacular winners, your overall portfolio only inches up by a few percentage points.
Similarly, if you hold say 12 equities only funds across various styles and themes, each fund makes up about ~ 8–9% of your portfolio. Suppose one fund doubles in a year (100% gain), but that fund contributes just 8–9% to your total portfolio return, barely moving the needle.
Meanwhile:
- Your exposure is still heavily tilted to equities
- Your drawdowns still mimic the market
- Your real risk hasn’t changed
That’s when you end up with something no investor wants: – A portfolio that looks diversified but behaves like a crowded, and equity-only strategy.
This brings us to the first big learning:
“Diversification isn’t about quantity — it’s about meaningful differences.”
“Owning a lot of similar things still means you own the same thing.”
2. The Reset: Think of asset classes
This is the moment for a mindset shift. Instead of asking, “How many funds should I own?” start asking, “Which asset classes should I own?”
True diversification begins here…
Your core portfolio only needs a few essential building blocks: Equity for long-term growth, Debt for stability and Gold/real assets/or alternatives to provide a cushion during inflationary or uncertain periods.
Viewing your portfolio through the lens of asset classes rather than individual funds is likely to make the overall picture much clearer and more purposeful.
May be start by asking the right questions:
- Do I have something that moves differently from equity?
- Do I have assets that could safeguard my portfolio in cycles when equity is weak?
What most investors are likely to discover is that: They didn’t need more equity funds – they needed actual diversification across behaviorally different asset classes.
This is the second major insight:
“Diversification means having a mix of asset classes in the portfolio with different behavior patterns, not just holdings”.
3. The Underrated Asset Class : Debt
Now let’s talk about the underrated, asset class in most portfolios: Debt.
When many investors hear the word “debt,” they instantly think: Low return, Boring, Safe but dull, and the best – Only for conservative people…
But this thought is incomplete and quite outdated. Debt plays a crucial role that many investors may not recognize.
Let’s break down why debt is such a powerful and strategic partner to equity.
- Debt gives you predictable, returns
In India, medium-term debt instruments generally offer 6–8% annual returns with lower volatility than equities.
This range may not excite aggressive investor groups, but it does something far more useful – It provides consistency, especially during tough market phases.
Table 1: Risk and Return Data for the last 20 years for Equity and Debt as asset class
| Risk – Return | Equity | Debt |
| Annualized Returns | 12.0% | 7.3% |
| Annualized SD | 21.0% | 3.1% |
| Maximum Drawdown | -54.7% | -6.3% |
Equity Index: Sensex Debt Index: Crisil Composite Bond Index
Past performance may or may not be sustained in the future.
We analyzed the last 20 years data (FY 2005-FY 2025) and found that the maximum drawdown for equities exceeded 50%, while for debt it remained below 7%.
Over the same period, equities generated a CAGR of approximately 12%, compared to around 7.5% for debt.
This indicates that while equities can deliver higher returns, they come with higher volatility and risk too, as reflected in the larger drawdowns, whereas debt provides relatively lower returns with relatively stable performance.
- Debt helps reduce portfolio volatility
Equity and debt don’t move together.
Their correlation is often low and during equity downturns, the relationship becomes even weaker.
Table 2: Correlation between Equity and Debt for the last 10 years
| Correlation – 10 years | Large Cap | Mid Cap | Small Cap | Debt | |
| India Markets-Equities/Debt | Large Cap | 1 | 0.88 | 0.81 | 0.09 |
| Mid Cap | 0.88 | 1 | 0.96 | 0.04 | |
| Small Cap | 0.81 | 0.96 | 1 | 0.01 | |
| Debt | 0.09 | 0.04 | 0.01 | 1 | |
This means debt is not simply “not falling as much.” It’s often actually providing stability when everything else is shaking. This is why mixed equity–debt portfolios have historically fallen less in bad times, and also recovered faster.
- Debt becomes attractive in certain cycles
Many investors assume equity always outperforms debt. In reality, there are cycles where debt performs better (Say for example – When interest rates rise or when equity valuations stretch or when risk sentiment weakens or When markets move sideways for long periods).
During these phases, debt doesn’t just “safeguard capital” – it also performs better than equities on a risk-adjusted basis.
So, it’s a strategic companion – the counterweight that keeps the portfolio balanced.
Here’s the third major insight: Debt is not about giving up returns – it’s about gaining the ability to stay invested long enough to reap them.
How Debt Could Help Your Portfolio in Practice?
Relying solely on equity can expose your portfolio to market swings, and a 2–3 year equity slump can delay your financial goals.
Adding meaningful debt ~(20–40%) in your portfolio, could potentially change the equation. It could soften drawdowns, reduce volatility, provide steady income, and make rebalancing easier.
This stability can help keep your emotions in check as well, ensuring you stay invested, recover faster, and ultimately can help improve long-term outcomes.
In wealth creation, returns matter. But staying invested matters even more, and debt is the tool that makes it possible.
So… how much debt is “right”?
There’s no universal formula.
As an illustrative example, investors with a long-term horizon who can tolerate some volatility could consider a smaller portion in debt, around 20–30%. Those with a medium-term horizon or a preference for balance could potentially hold a larger share, roughly 30–40%, while for shorter horizons or lower risk tolerance, the debt component could be around 40–50%. These are only illustrative ranges, and the actual allocation would depend on individual circumstances, risk appetite, and investment objectives.
Investors can also explore an active Multi-Asset Allocation strategy to achieve diversification. However, they should also consider their core portfolio approach for such funds, as an excessive equity tilt can again compromise diversification, while too many asset classes may dilute overall returns.
It’s also important to remember that not all debt is the same – investors should consider factors like duration, credit risk, and maturity when selecting debt instruments to ensure they align with their goals and risk profile.
After everything we’ve discussed, one message stands tall:
Real diversification is not about owning more. It’s about owning wisely.
You don’t need 20 funds, every market theme, or exposure to hundreds of stocks. What you truly need is a strong growth engine through equity, a reliable stabilizer in debt, a simple and disciplined allocation, and a consistent rebalancing habit. Debt isn’t about reducing your returns—it protects them, safeguards your behavior, and preserves your time horizon, allowing you to stay invested and achieve your long-term goals.
So the next time you think of diversifying, ask yourself:
“Am I adding meaningful difference — or just adding more of the same?”
Sneha Pandey is Fund Manager for Fixed Income and Multi-Asset Allocation Funds at Quantum AMC
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