When it comes to investing in equity funds, Indian investors have a lot of choices. In fact, a little too much choice. There are almost 40 AMCs offering schemes in almost each of the 10+ equity fund categories. So just in the equity fund space, there are at least 300+ options for investors to choose from.
But while the choice of funds can get overwhelming, investors themselves don’t regularly review and clean up their mutual fund portfolios. Most investors start investing in a fund or two. But then, and over a period of next few years, they keep adding new funds to their portfolio. And most of them don’t look at cleaning up their portfolios.
The result is that very often, investors end up with a portfolio of an unnecessarily large number of funds. And it’s quite common to see several funds of similar types in portfolios in the name of diversification. But while diversification is important, it doesn’t mean that you keep adding new funds to your portfolio.
Investing in too many funds, and justifying it as diversification, is redundant. Beyond a point, there are no additional (diversification) benefits available if you increase the number of funds in the portfolio.
Let’s understand this with a few examples to drive home the idea.
Suppose you decide to invest inlargecap funds. And to ensure that you are properly diversified, you pick 3 active large cap funds and 1 large cap index fund. Now you may feel that you are diversifying well. But the reality is different. As per SEBI’s categorization rules, a large cap fund needs to invest at least 80% in stocks of only the top-100 companies.
Now if you open the bonnet (or underlying portfolio) of each of these large cap funds, you will see a lot of similar names as the universe of stocks available to be invested is limited by SEBI rules.
So, to a large extent, each of the funds you have chosen will have a lot of overlap with each other. There will be no real diversification if you increase the number of pure large cap funds in your portfolio. Just investing in 1-2 large cap funds, whether active or passive or both, is more than enough for most investors.
If you really want to diversify, you need to invest across different fund categories and not just within a category. That way, the above-average performance of one category can offset the underperformance of another category at any given time.
That was about large cap funds. But what about other popular categories like flexicap funds, midcap funds, smallcap funds?
While passive funds are advisable for large cap funds, for mid-&-smallcap exposure, there is still a lot of potential for alpha generation via active investing by good fund managers. So, if one has to not have too many funds in the mid & smallcap categories, then one can go for 1-2 proven, well-managed, activemidcap funds and depending on the size of the overall portfolio 2-3smallcap funds.
For picking funds from theflexicap category, 1-2 funds are enough provided the inter-scheme overlaps are limited and there is style diversification.
But it must be noted that midcaps and smallcaps can be very volatile in the short term and hence, the total exposure to these two market segments, across all funds combined, should be limited to a maximum of 30-40% for most investors. The rest 60-70% should be to large caps.
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. That is assuming one doesn’t have too many fund categories in their mutual fund portfolio in the first place.
Dev Ashish is a SEBI-Registered Investment Advisor and Founder (Stable Investor). He provides fee-only financial planning and investment advisory services to small and HNI clients across India.
First Published: 27 May 2023, 12:31 PM
IST
FAQs
But while diversification is important, it doesn't mean that you keep adding new funds to your portfolio. Investing in too many funds, and justifying it as diversification, is redundant. Beyond a point, there are no additional (diversification) benefits available if you increase the number of funds in the portfolio.
How many mutual funds should you have in your portfolio? ›
Investors should strive to build a diversified portfolio of roughly 10 to 15 mutual funds encompassing a range of asset classes and investment techniques. Mid-cap equity mutual funds invest in businesses with medium market capitalizations to balance growth potential and risk.
Why are mutual funds considered a high risk? ›
High-risk mutual funds are those that invest in stocks or equity that have a higher risk of losing value. These funds are also known as equity funds or growth funds. They are designed for investors who are willing to take on more risk in exchange for the potential of higher returns.
How many funds is too many in a portfolio? ›
Financial planners say it is difficult to put a cap on the number of schemes in an investor's portfolio, as investors increasingly use mutual funds to meet both long-term and short-term goals. However, they feel investors should restrict themselves to 10 schemes, as a higher number is difficult to monitor and manage.
Should you have mutual funds in your portfolio? ›
Access to different markets
You might also need an investment to serve a specific role in your portfolio, such as generating income or adding stability during periods of market duress. Mutual funds can provide access to many different parts of the market, even within the broad asset classes of stocks and bonds.
Is it wise to have multiple mutual funds? ›
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.
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 mutual funds too risky? ›
Mutual funds are largely a safe investment, seen as being a good way for investors to diversify with minimal risk. But there are circumstances in which a mutual fund is not a good choice for a market participant, especially when it comes to fees.
What is the dark side of mutual funds? ›
Disadvantages include high fees, tax inefficiency, poor trade execution, and the potential for management abuses.
What are the cons of mutual funds? ›
Potential for loss: Mutual funds are not FDIC insured and may lose principal and fluctuate in value. Cost: A mutual fund may incur sales charges either up-front or on the back end that are passed on to the investors. In addition, some mutual funds can have high management fees.
Understanding when you have too many funds
While it's important to make sure your portfolio is properly diversified, having too many funds can make it difficult to keep track of your investments. You should therefore only keep as many funds in your portfolio as you're comfortable monitoring.
Is it bad to have too many stocks in portfolio? ›
It's all about moderation
If you make a point to load your portfolio with stocks across a range of market sectors, you'll have more protection when one sector takes a beating. But while it's definitely a good idea to own a few dozen stocks, you don't want to load up on too many.
How much of portfolio is high risk? ›
You should put no more than 10% of your total net assets in high-risk investments, with the remainder diversified across a range of mainstream investments. Read our article about how diversification can work for your investments.
What are the pros and cons of mutual funds? ›
One selling point is that they allow you to hold a variety of assets in a single fund. They also have the potential for higher-than-average returns. However, some mutual funds have steep fees and initial buy-ins. Your financial situation and investment style will determine if they're right for you.
Are mutual funds more risky than stocks? ›
A mutual fund provides diversification through exposure to a multitude of stocks. The reason that owning shares in a mutual fund is recommended over owning a single stock is that an individual stock carries more risk than a mutual fund. This type of risk is known as unsystematic risk.
What does a good mutual fund portfolio look like? ›
What is a good mutual fund portfolio? A good mutual fund is one that aligns well with your goals, resources, and risk tolerance levels. Selecting mutual funds based on your goals and risk-taking capacity will help you achieve your goals faster and manage your portfolio better.
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 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 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 an ideal mutual fund portfolio? ›
How much should I allocate to a mutual fund portfolio? Ideally, you must save and invest 20% of your income. Your portfolio allocation will depend on your goals and risk appetite. Equity is the best for long-term goals and high-risk takers.