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Building a Diversified Fund Portfolio

Investing in a large number of funds doesn't necessarily mean you're adequately diversified

How many funds should I invest in for my retirement portfolio, which has 10-15 years to go?
- Omkar Dutt

When it comes to investing you should focus on the quality of funds that you invest in than the number of funds. It is for this reason that diversification is the most valuable quality that mutual funds bring to your investments. However, there is a correct amount of diversification and having too much of it is pointless, just as having too little is risky.

The idea of diversification is straightforward. Stocks of different kinds of companies tend to do well or do badly at different times. By different types of companies we mean different sectors, different parts of the world or even some financial parameter like different levels of interest cost.

In any well-managed fund, this spread is balanced not just across different companies but also across different sectors and sizes of companies, thus providing optimum safety. For the investor who is putting his money in funds, the only diversification that is needed is between different fund managers. At Value Research, we feel 4 or 5 funds are enough to provide this kind of diversification. No additional diversification is provided by investing in more funds. The reason is that the stocks held by these funds' tend to be a similar set.

Moreover, with a larger number of funds you are effectively adding more funds similar to some other fund that is already there with you. Too many funds devalue a major attraction of investing in mutual funds, which is convenience and ease of tracking fund performance. Having too many funds in your portfolio would amount to tracking and evaluating their performance frequently, which only adds to your work and takes away the convenience of investing. What you do need to ensure is that the small number of funds you have are of different types and are managed by different fund managers.

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