How Many Funds Should You Own in Your Portfolio

If you have started financial planning, you know that diversification of assets is of utmost importance. Not only does it help you balance the risk of your overall portfolio, but it also helps you choose assets that hold the potential to help you achieve your financial goals. If one market or asset class crashes suddenly, it is less likely for other industries or asset classes to underperform at the same time in tandem. However, over diversification can not only hamper your long term capital appreciation, but it might also leave you confused over which asset class is more suitable for your investment objective.

Although financial advisors recommend investors to diversify their portfolio to manage unforeseen risks, how much diversification to allow is entirely depending on you as an investor and your short term and long term financial goals.

Over diversification in mutual funds. How much is too much?

The whole idea behind diversification is to not keep all your eggs in one basket. The equity market is unpredictable and hence placing all your bets on just one mutual fund category is like exposing your finances to the market's volatile nature. In order to mitigate this risk, it is essential that you spread your finances across multiple asset classes. To further save yourself from falling markets, you not only invest in various asset classes but also invest in mutual funds belonging to different industries, for example, ESG, gold, PSU etc. This is not a bad investment strategy because for example if the equity markets fall tomorrow, your investments in gold funds will help you even out the losses.

However, in order to save yourself from the market's volatile nature, you are investing in too many mutual funds at once and over diversifying your mutual fund portfolio. This way even if your investments in other asset classes are performing well, you aren’t able to achieve higher capital appreciation from any of the asset classes because you have spread your finances across too many investment avenues.

Thus, to save yourself from this misery one should remember to not over diversify their mutual fund portfolio and keep their investment objective in mind while applying the diversification strategy. Like restricting to asset classes is essential while diversifying your mutual fund portfolio, so is restricting to industry specific investing. That’s because when you invest in mutual funds like equity funds, they already carry a diversified portfolio that consists of stocks of several companies.

How many mutual funds should one include in their portfolio?

Before deciding on how many mutual funds you should invest in to give adequate diversification, you need to understand the types of mutual funds that are available for investment.

Accordingly, to SEBI* - large cap, mid cap and small cap as follows:

1. Large Cap: 1 st -100 th company in terms of full market capitalization b. Mid Cap: 101 st -250th company in terms of full market capitalization c. Small Cap: 251st company onwards in terms of full market capitalization

Then there are hybrid funds that invest in both equity and debt. A conservative hybrid fund allocates the majority of its assets to debt securities and remaining to equity related instruments. An aggressive hybrid fund predominantly invests in equity, while the remaining of its assets are allocated to debt related instruments.

Now there are some investors who do not wish to expose their finances to the dangers of equities. Such investors can diversify their mutual fund portfolio with debt funds or rather allocate more of their assets to debt funds. If you are planning to build an emergency fund, which you should ideally use to help you tackle life’s unexpected financial emergencies, a liquid fund can be a decent choice. For short to medium term goals and for those with an investment horizon of 1 to 3 years, one can consider investing in a short duration fund.

If you are completely new to investing and do not have the time to keep a check on your investments every now and then, you can consider investing in an index fund that tries to replicate its underlying benchmark with minimal tracking error.

These are just a few of the many other mutual fund schemes available for investing. Now how many mutual funds you should invest in or rather in which asset class you should invest more or less will totally depend on your risk appetite and your investment objective. Here’s an example of how you can diversify your portfolio – you can invest in one equity fund, one debt fund and one gold fund. This way you will invest in different asset classes and also invest in different industries. Now do bear in mind that this was just an example and should be taken in a literal sense. Talk to a financial advisor, they might help you in making a more informed investment decision or download our mutual fund app to learn more!.

*Source - https://www.amfiindia.com/Themes/Theme1/downloads/1507291273374.pdf

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.