Diversification is one of the most critical principles of investing. The objective of diversification is to avoid concentration of any single investment or asset class in your portfolio, thereby reducing overall risk and optimally positioning your portfolio for long-term wealth creation.
Investing in diverse asset classes like Equity, Debt and Gold, which from a performance perspective, are not correlated to each other, can empower a smart investor to diversify his/her investments. The proportion of investments in respective asset classes should be a function of risk appetite and financial goals of the investor.
For example, an investor with a 5-year investment horizon and a moderate risk profile can consider allocating 30% to equity investments, 60% to fixed income assets and 10% to gold. The equity allocation shall enable long-term wealth creation, fixed income allocation shall enable stable and consistent returns, and gold allocation shall act as an inflation and volatility hedge.
While diversification across asset classes is critical, it is also important to diversify within an asset class. As an example, if an investor invests directly in stocks, it is prudent for them to diversify across multiple stocks of different sectors and sizes so as to avoid concentration risk to their entire investment corpus in case certain stocks fail to deliver.
Taking the above example forward, out of the 30% equity allocation, investors may look at parking 24% in largecaps which are established businesses and thus more stable, and 4% and 2% can be allocated to mid and small-cap companies to position the portfolio for growth while at the same time optimising market risks.
Mutual funds have become increasingly popular and have established themselves as an investment product of choice for High Net Worth as well as retail investors. Mutual funds offer the professional expertise of the fund manager, are diversified instruments, transparent in terms of management and offer investors simple and seamless access to capital markets.
From a diversification standpoint, mutual funds invest in 40-70 stocks on average, which is already well diversified. It becomes crucial that investors select an appropriate number of Mutual Fund schemes. For example, if an investor invests in 8-10 equity mutual funds, there could be a reasonably high overlap in terms of underlying investments resulting in diversification which neither helps in reducing portfolio risk nor helps in enhancing returns.
Another big challenge is that it becomes increasingly difficult for investors to track and review each fund in the portfolio when there are a large number of funds. Conducting an annual review of your portfolio is crucial to ensure that you have the right set of funds in your portfolio to achieve your long-term financial objectives.
To de-clutter and simplify your portfolio while ensuring adequate diversification, you may consider the following measures. The first step is to accord meaningful weightage to the best-performing funds. Schemes should be evaluated on an individual level as well as should be compared with their peers periodically.
Schemes which are lagging in performance on a sustained basis should be evaluated and weeded out. Secondly, investors should try and avoid investing in too many schemes from the same Mutual Fund category.
Lastly, one can research and avoid investing in funds that have a major holding overlap with each other. Investors should conduct a periodic assessment of one’s own financial goals and risk appetite to determine the asset allocation strategy and rebalance/exit from mutual fund schemes, which are not in-line with the same. To make this process more disciplined and professional, investors may take the help of a financial advisor.
While there is no precise answer for the number of funds one should hold in a portfolio, 8 funds (+/-2) across asset classes may be considered optimal depending on the financial objectives and goals of the investor. Further, higher allocation of portfolio to the right fund is of crucial importance. There is nothing wrong in deviating from the said number; however, one’s decision should be well-informed after taking into consideration their holistic investment goals and objectives.
(The author, Virendra Somwanshi is the Head of Wealth Management, Capital Markets & NRI at Bank of Baroda. Views are personal)
(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)
FAQs
How many funds are enough? 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.
What is the ideal number of mutual funds in a portfolio? ›
How many funds are enough? 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.
What is the optimum number of funds in a portfolio? ›
But most investors will find that more than 20 or 25 funds is way too many to keep track of — and it may not be necessary. In our own interactive investor model growth and income portfolios, we believe that we can achieve enough diversification with between eight and ten funds.
Is 4 mutual funds too many? ›
However, analysts say that at any point of time, three to five mutual funds . A few multi-caps, combined with one large-cap and a mid-cap, should do the trick. If your appetite is a high-risk one, then you may pick a fund of small-caps. Additionally, you should make sure that funds you pick don't hold the same stocks.
How many different mutual funds should I have in my portfolio? ›
While there is no precise answer for the number of funds one should hold in a portfolio, 8 funds (+/-2) across asset classes may be considered optimal depending on the financial objectives and goals of the investor. Further, higher allocation of portfolio to the right fund is of crucial importance.
Is the 3 fund portfolio good enough? ›
The three-fund portfolio is a sound investing approach, and you can't go wrong with it. If you set up asset allocation appropriate for your age, a three-fund portfolio will most likely perform well. I say "most likely" because nothing is guaranteed with investing, but this strategy is one of the safer options.
Are 10 mutual funds too many? ›
There is no one right answer to questions like how many funds should I invest in. But just adding new funds to the portfolio to 'diversify' or reduce risks doesn't work. So, in general, having 1-2 schemes in the chosen fund category would be sufficient.
What is an optimal portfolio? ›
An optimal portfolio is one that minimizes your risk for a given level of return or maximizes your return for a given level of risk. What it means is that risk and return cannot be seen in isolation. You need to take on higher risk to earn higher returns.
How do you determine the optimal portfolio? ›
To assess whether a portfolio is genuinely optimal, consider the investor's tastes and aims. This frequently entails analyzing the investor's overall approach to finances. 1. A conservative investor may be quite uncomfortable with the purchase of assets with high volatility.
How do you find the optimal portfolio? ›
The optimal risky portfolio is found at the point where the CAL is tangent to the efficient frontier. This asset weight combination gives the best risk-to-reward ratio, as it has the highest slope for CAL.
Investing in multiple mutual funds can be a smart move for investors who want to diversify their portfolios and gain access to professional asset management. However, it's important to be aware of the possible drawbacks, such as the potential for over-diversification and higher transaction costs.
What is the 20 25 rule for mutual funds? ›
It states that you should invest in no more than 20 mutual funds and no more than 25% of your portfolio in any one fund. This rule helps you avoid overexposure to a single fund or sector, and reduces the complexity and cost of managing your investments too.
Is it good to have several mutual funds? ›
While mutual funds are popular and attractive investments because they provide exposure to a number of stocks in a single investment vehicle, too much of a good thing can be a bad idea. The addition of too many funds simply creates an expensive index fund.
How do I reduce the number of mutual funds in my portfolio? ›
Assess The Need for Mid/Small-Cap Funds
Only those who are willing to take extra risk for extra returns should invest in them, that too for no more than 30% of your portfolio. If you don't want to take extra risk, you can exit the mid/small-cap funds in your portfolio.
Is it smart to have multiple portfolios? ›
Yes, absolutely! Having multiple investment portfolios can be beneficial for several reasons: Diversity and Focus: Different goals: You can tailor each portfolio to specific financial objectives.
What 4 mutual funds should you invest in? ›
Best-performing U.S. equity mutual funds
| Ticker | Name | 5-year return (%) |
|---|
| FGRTX | Fidelity Mega Cap Stock | 16.52% |
| STSEX | BlackRock Exchange BlackRock | 16.27% |
| USBOX | Pear Tree Quality Ordinary | 16.13% |
| FGLGX | Fidelity Series Large Cap Stock | 16.08% |
3 more rowsMar 29, 2024
Diversified management investment companies have assets that fall within the 75-5-10 rule. A 75-5-10 diversified management investment company will have 75% of its assets in other issuers and cash, no more than 5% of assets in any one company, and no more than 10% ownership of any company's outstanding voting stock.
What is the 15 15 rule of mutual funds? ›
What is the 15x15x15 rule in mutual funds? The mutual fund 15x15x15 rule simply put means invest INR 15000 every month for 15 years in a stock that can offer an interest rate of 15% on an annual basis, then your investment will amount to INR 1,00,26,601/- after 15 years.
What is the 4% rule for mutual funds? ›
The 4% rule says people should withdraw 4% of their retirement funds in the first year after retiring and take that dollar amount, adjusted for inflation, every year after. The rule seeks to establish a steady and safe income stream that will meet a retiree's current and future financial needs.
What is the 80% rule for mutual funds? ›
The Final Rule's 80% basket is 80% of the fund's assets. “Assets” is defined to mean “net assets, plus the amount of any borrowings for investment purposes” and subject to certain rules and exclusions described in this Section IV.
