Don’t put all your eggs in one basket. Diversify your investments. These words of wisdom are hammered into the minds of people looking to invest. While diversification is a crucial element and should be taken care off, most investors tend to go overboard and stuff their portfolio with a large number of funds
This can be counterproductive as a messy portfolio is difficult to track and manage.
So how many funds should you invest in to build a sufficiently diversified portfolio? Well, we read on to know all about it.
Let’s first talk about the number offunds
Yes. You should invest in more than one fund. While most mutual funds are inherently diversified, putting all your money in one fund means you are relying on the judgment and investing style of one person. This gives rise to fund manager risk, and this can work against you. That’s because even the best of fund managers can go wrong.
Now that we have established that your portfolio should have more than one fund let’s go to the next question.
How many funds areenough?
One thing you should always remember is that a lot of funds in your portfolio doesn’t mean you have a diversified portfolio. A portfolio with 15 funds that have overlapping is not diversified.
You should have no more than 4 funds in your portfolio. You don’t get any additional diversification if you invest in more funds.
That’s because most funds of a category invest in the same set of stocks, so buying more funds just means you are loading up on the same stocks via different funds
With the number of funds defined, we move to the next piece of the puzzle.
Should you pick these funds from the same category or different categories?
Well, it is ideal you pick fund from different categories. That’s because you will have exposure to different parts of the market and since stocks of different kind of companies tend to do well or do poorly at different times, your risk is reduced.
So, now that you know you need different categories, what those 4 categories to go for.
1. ELSS Fund - This is the first fund any investor should buy. Not only it helps you save tax, but they are also multi caps funds under the hood. You can read more about why ELSS should be your first category.
2. Aggressive Hybrid Fund - These funds were earlier called Balanced Fund. This fund category invests at least 25% in debt allowing you to have some exposure in another asset class.
3. Multi cap Fund - These funds invest in companies of all sizes and across sectors. There go anywhere approach allows them to invest in the best ideas across the market and in the process build a diversified portfolio.
4. Large and Mid Cap Fund - This category of fund invests primarily in the top 200 companies in India. So you get a portfolio of leaders of today (large caps) and the potential leaders of tomorrow (mid caps).
Bottomline
A portfolio doesn’t need to have a lot of funds to be diversified. You just need to pick 3–4 categories and invest in one fund from each of those categories and you are done.
As an investment enthusiast with a deep understanding of portfolio diversification, let's delve into the key concepts mentioned in the article about mutual funds.
Diversification is indeed a fundamental principle in investing, and the article rightly emphasizes the importance of not putting all your eggs in one basket. Now, let's break down the key points:
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Fund Manager Risk: The article highlights the risk associated with relying on the judgment and investing style of a single fund manager. Even the best fund managers can make mistakes, leading to potential downsides. This underscores the need for diversification to mitigate this specific risk.
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Number of Funds: While diversification is essential, the article provides a guideline on the number of funds an investor should have in their portfolio. It advises against having too many funds, as a messy and overly complex portfolio can be counterproductive. The recommended number is no more than 4 funds.
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Overlap and Real Diversification: The article cautions against mistaking a high number of funds for true diversification. Having 15 funds with overlapping stocks does not necessarily create a diversified portfolio. Real diversification involves selecting funds that provide exposure to different sectors and asset classes.
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Categories of Funds: The article introduces four categories of funds that investors should consider for a well-rounded and diversified portfolio:
- ELSS Fund: Provides tax benefits and operates as multi-cap funds.
- Aggressive Hybrid Fund: Formerly known as Balanced Fund, it allocates at least 25% to debt, offering exposure to another asset class.
- Multi Cap Fund: Invests across companies of all sizes and sectors, following a go-anywhere approach for optimal diversification.
- Large and Mid Cap Fund: Focuses on the top 200 companies in India, offering a blend of established leaders (large caps) and potential future leaders (mid caps).
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Choosing Different Categories: The article advises investors to select funds from different categories to ensure exposure to various parts of the market. This approach helps mitigate risks associated with the performance of specific types of companies at different times.
In summary, the bottom line is that a diversified portfolio doesn't require a multitude of funds. Instead, investors can achieve diversification effectively by selecting 3–4 categories and investing in one fund from each of those categories. This approach aims to strike a balance between risk management and optimal market exposure.
