Beware of Over-diversification

If you invest in too many funds then you need to keep track of many funds, which is an unnecessary burden


Why is it advisable to not invest in more than 8-10 funds? I think we can get good returns by investing in more schemes so that if one fund fails to deliver, we can get good returns from the others. Is this advice given for SIP investments or for lump sum investments?
- Sonia

Increasing the number of funds is not a smart way of diversification. Ideally, 5-6 funds are sufficient to provide the diversification that one must have in his portfolio. By having a large number of funds, you might think that you are carrying out additional diversification but in reality it is not so. It forms a case of over-diversification. The more diversified a portfolio is, the less chance it has for superior performance.

It is important to know that if you invest in a large number of funds, then there can be many common stocks in which these funds invest which is nothing but a repetition. Your overall portfolio will also have exposure to a large number of stocks which is nothing but over-diversification. A large number of stocks are not at all necessary. What is important is that there must be a set of quality stocks. Also, it is very much possible that a lot of stocks in your total portfolio will have an allocation of less than one percent.

Apart from affecting the performance of your overall portfolio, a large number of funds will also face the manageability issue. You need to keep track of many funds, which is an unnecessary burden. Add to it the load or charges incurred for investing in so many funds. Few well-rated funds will provide adequate diversification to your portfolio and will also make it more manageable by reducing the paperwork. With this you would also be able to closely monitor the performance of your funds.

This advice goes for one's overall portfolio. It does not matter whether you are investing lump sum or through SIP.



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