New Delhi [India], November 14: Diversifying into multiple schemes with the same style or objective is a big mistake! Investors often search for “best funds” or “top performers”. When people find out I am a research analyst, they usually ask me, “Which fund do you think is the best?” or “I just invested ₹1 lakh in a Mutual Fund; do you like it?” It becomes challenging to explain to them that this is not the way to make intelligent and informed investment decisions.
Not to mention all the churning as one fund is exited and another entered, leaving investors with multiple schemes that look the same.
How to Diversify?
Investors sometimes need to remember the primary goal of mutual fund investing: creating long-term wealth. To start, consider your investment horizon and risk tolerance while selecting mutual funds to invest in.
Mutual funds vary significantly by strategy and market size, from funds geared toward growth opportunities or value investing or specific market caps like large, mid, small or micro to flexi-caps covering multiple categories like Index Funds for tax savings purposes as well as Flexi-caps covering various asset classes or speciality index funds such as ELSS tax savings vehicles for tax planning or sector focused funds like Flexi-cap. There are also multi-asset funds, arbitrage funds, equity savings, multi-asset arbitrage, as well as debt funds. For example liquid, money market funds to corporate bonds and gilt funds among debt funds available options in debt funds.
Dezerv can customize your investment approach based on your risk tolerance and long-term goals, offering personalized investment advice tailored specifically to you.
Risk Appetite-Based Portfolio Allocation
An over-diversified mutual fund portfolio could expose hidden costs and risks, which in turn reduce overall returns. While diversification is an effective tool for mitigating risks, overexposure can backfire – you can consider these critical considerations before diversifying further:
- Reducing Costs- Investors who are too diversified may overlook transaction costs, expense ratios, and other potential risks.
- Over-Rely on Star Performers- Adding funds with high performance without first reviewing their goals can lead to poor returns in times of market decline.
- Mid-cap Fund Volatility—Mid-cap funds may give excellent returns during rallies but can also decline sharply during downturns, this leads to portfolio instability.
- Fund Overlap and Increased Risk— Mutual funds with similar goals can sometimes overlap, especially during sector or stock investing. This increases portfolio risk rather than decreases it.
- Cost and Complexity Concerns: Each new fund adds expenses and paperwork but may not lead to better performance.
How Many Schemes Should You Hold?
There’s no magic number when it comes to building the perfect portfolio, as risk diversification doesn’t require 12 separate schemes; one diversified equity fund could provide adequate protection across different sectors while not necessarily covering every style available.
Points to remember for an ideal mutual fund portfolio:
- Invest in funds with different characteristics that behave differently.
- Limit the number of investments in your portfolio.
- Match your investment goals and objectives with your portfolio.
- Don’t invest in equity funds if your goal is capital preservation.
- Rebalance your portfolio.
As your portfolio becomes more complex with more schemes, many people need clarification about what to do with their mutual funds and how to balance them. They often need clarification on what they are holding.
What Is Optimum Portfolio Diversification?
An optimal portfolio diversification strategy involves owning individual investments with sufficient diversification. It nearly eliminates unsystematic risk while remaining small enough for investors to focus on finding opportunities.
Due to variations in industry and sector performance, not all industries or sectors experience fluctuations at the same time or rate. Diversification may reduce the risk of individual stocks (what academics refer to as unsystematic risk). Almost every stock still has inherent market risks (systematic risk), and no amount of diversification can negate this fact.
A practical or optimal diversification plan typically involves diversifying across 15 to 30 assets for optimal risk mitigation. Diversifying investments effectively would involve spreading them among various sectors and industries.
At its core, investing in 30 of the best stocks across various industries could be more efficient than owning 30 great ones plus 970 suboptimal stocks that detract from its performance.
Simply stated, owning 970 additional stocks would likely bring minimal added benefits relative to their expected loss in return.
Most investors have experienced the negative results of over-diversification. This is often caused by institutional vehicles such as mutual funds, pension funds, equity index funds, and ETFs that are over-diversified, leaving no time or ability to invest in quality over quantity.
Conclusion
Compare mutual fund portfolio overlap and your existing portfolio to identify any overlap in sectors or stocks between funds. Diversifying your portfolio effectively is equally important, but finding the right amount of diversification may prove to be just as crucial. Regular rebalancing and review will help prevent overlaps from building long-term wealth. Dezerv is here to help you diversify and invest wisely. Contact our investment advisor or counselor if any questions about mutual fund portfolio overlap, investment strategy, or asset allocation arise.
Syndicated press content is not written by ED Times
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