Investors tend to think that investing in a large number of funds will allow them to diversify more. But that is merely an illusion
23-May-2014 •Saurin Parikh
Recently when I was surfing the web (how did people get through an entire working day without the internet?), I came across this very interesting study on why men collect things. The bracketed question in the previous line is something that most of us would consider to be an extremely scary thought, but that apart, most of us will also acknowledge how much we love collecting stuff - men and women.
As humans, we're hoarders. Take a look around you - how many things are there on your desk that you don't actually need? Look into your cupboards and drawers - same story. Women, look into your purses - there's always some hidden treasure to be found among the debris in there. We collect things, even when we don't have any practical purpose for them.
I had the hobby of collecting trump cards when I was a kid. The class geniuses in my school collected stamps, while the back-benchers usually collected GI Joe action figures. I had a few of those myself, but that didn't go far because my dad wasn't interested in sponsoring my hobby of collecting action figures. He did let my sister have a large collection of Barbie Dolls, but, I digress. The point is that we love to collect things. And this study that I'm referring to says that as far as men are concerned, men collect things to impress women.
Yes, as per this 2011 study by the Journal of Economic Psychology, a man who collects items is considered to be dedicated and hard-working. Hence, good husband/boyfriend material. A woman and her family would look at a collector as someone who is resourceful enough to support her and their children. In a nutshell, men become collectors because it helps them get partners.
Now, there's nothing wrong with that. Collecting things can be a very good, productive hobby as well. But, while reading this study, I realised that there's one certain set of items that shouldn't be collected as rigorously as trump cards, stamps or action figures. That set of items is mutual funds.
In case of the former three, the more you have the better your collection. But in case of funds, the inverse is true. A collection of a large number of funds is nothing worth showing off. When it comes to funds, the fewer the better.
This is a common mistake that a lot of investors make. They tend to think that investing in a large number of funds will allow them to diversify more. But that is merely an illusion. To diversify adequately, what your portfolio should have is different kinds of funds, not a lot of funds. For example, having 5 large- and mid-cap funds doesn't necessarily mean you've a diversified portfolio. Your investments would be diversified when your portfolio would look something like this - a couple of large- and mid-cap funds, one small-cap fund, one dividend yield fund and maybe a balanced fund. Such an allocation would give you diversification across sectors, market capitalisations as well as investment styles. Investing in a lot of funds from the same category wouldn't have the same effect.
We, at Value Research, often come across portfolios with around 25-30 funds. That's 20-25 more than what you should ideally have. For most investors, 5-7 funds from different categories would suffice. Such a portfolio would be adequately diversified, easier to manage and better performing as well.
So, whether you've carried on your childhood hobby of collecting things to adulthood or not, make sure this inclination doesn't get carried forward to your investment decisions as well. Too many funds are never going to impress any of the ladies, and they won't have an impressive effect on your overall returns either.
This column first appeared in May 2014.