Why diversification is important in Mutual Fund Investment?

If you have ever considered having an investment portfolio, you may be aware about the fact that every investment carries a certain risk and hence it is better to not lay all your eggs in one basket. Financial experts advise investors to have a mix of conservative and non-conservative investment avenues while spreading their finances so that they are able to tackle uncertainties that come with these investments. Whether you are a conservative investor or someone who is young and aggressive, if you are seeking capital appreciation through investments you will have to make sure that you diversify your investment portfolio so that you are able to balance your portfolio’s overall risk.

Managing risk is the key to financial planning. The last thing you want is to invest beyond your risk appetite and lose your investments to greed. There are some investment schemes that carry a high risk reward ratio, but remember that no investment guarantees you any returns, at least when it comes to mutual funds. Mutual funds are an investment tool that are becoming a favorite among several new age investors because of its unique investment portfolio allocation strategy.

However, anyone considering investing in mutual funds should try and wisely allocate assets so that they are able to face market uncertainties and potentially lower risk in the long run.

What are mutual funds?

Mutual funds are professionally managed funds where the fund manager buys/sells securities in accordance with the scheme’s investment objective. The money is invested across multiple money market instruments like equity, debt, government securities, corporate bonds, etc.

SEBI, the regulator of mutual funds here in India identifies mutual funds as, “a mechanism for pooling the resources by issuing units to the investors and investing funds in securities in accordance with objectives as disclosed in the offer document. Investments in securities are spread across a wide cross-section of industries and sectors and thus the risk is reduced. Diversification reduces the risk because all stocks may not move in the same direction in the same proportion at the same time. Mutual fund issues units to the investors in accordance with the quantum of money invested by them. Investors of mutual funds are known as unitholders.”

What is diversification in mutual funds?

Diversification refers to constructing a mutual fund investment portfolio that consists of securities from multiple asset classes like equity and debt. Diversification is all about spreading your finances across various asset classes. Diversification balances the risk of your overall portfolio. Generally the market value of all the asset classes does not rise or fall in tandem. For example, if the equity market crashes, the debt classes might be able to even out the losses. Diversification tries to make the overall performance of your investment portfolio slightly less volatile to market vagaries.

Why is diversification important in mutual funds?

Diversification might allow your investments in various asset classes to grow in the long run. The primary objective of diversification in mutual funds is to minimize the risk involved in building an investment portfolio. When you give your investment portfolio some diversification, it usually reduces the investment risk as the fluctuations in all asset classes may not move in the same direction in the same ratio at the same time.

The market is uncertain and you never know which sector may or may not crash, hence it is essential for every investor to have a diversified mutual fund portfolio. How an individual may decide to diversify her or her portfolio may depend on several factors like, age, income, existing liabilities, etc. For example, someone who is young and aggressive may want to have their mutual fund portfolio more equity oriented funds. On the other hand, an individual with a low risk appetite may want to invest more in debt and allocate lesser assets to equity.

Giving your mutual fund portfolio the right type of diversification may even help you in achieving your short term and long term financial goals. However, before investing your money in any mutual fund scheme, investors are advised to do some background research about the fund using the mutual fund app. Do check if the fund has been a consistent performer in the past. Also check for other things like the fund’s expense ratio, its CRISIL rankings, asset allocation, risk profile, etc. Also, if you are new to mutual funds or investing in general, feel free to seek some professional help.

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