Portfolio restructuring: How to restructure your mutual fund portfolio? | Value Research Are too many funds worrying you? Let’s understand how you can restructure your mutual fund portfolio and what should be an ideal mutual fund portfolio allocation strategy.
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How to restructure your mutual fund portfolio?

Too many funds worrying you? Here's how you can reconstruct your portfolio.

It's a common phenomenon to end up with too many funds in a portfolio for someone who has been investing for a long time. While diversification is a good idea, one must not overdo it. It has its own disadvantages. It may dilute the performance and may make it difficult for you to keep a track of your investments. Hence, we do not suggest investing in more than four to five funds because they are easier to manage. To understand more, you can check out our story on diversification.

If the investor has a broad portfolio that has low allocation across funds, it will not have a significant impact on our overall returns. Even if a fund performs well, it doesn't matter. Let's say you invested Rs 1 lakh equally across 20 funds. That would be just Rs 5,000 allocated to each fund (5 per cent of the portfolio). Now if a particular fund doesn't perform well or if something goes wrong, you may not worry much. It plays on our psychology on the funds that have just a 5 per cent allocation - we neglect them believing that those losses don't hurt us. But if this Rs 1 lakh was invested across four funds, the allocation would be 25 per cent and you would consciously monitor them. If they don't perform well, you might take necessary action. So it's recommended that we increase allocation to those funds that have performed well. And so, here are a few steps to restructure your mutual fund portfolio.

  • 1. Sell those funds that have a narrow exposure such as sectoral or thematic. These funds serve little purpose and can be a hit or a miss.
  • 2. Weed out the poor performers. We can look at their historical returns and we must remove them if they haven't performed well.
  • 3. Focus on just four to five funds that have a broad investment mandate.

Once we're clear on the changes, we can take time to move towards that goal. It need not be done in one day. It can be split between multiple financial years so that you can take advantage of tax harvesting. That is if your gain is up to Rs 1 lakh in a financial year, you can sell your investment, realise that gain and invest it back without being liable to pay taxes.

To avoid tax, we cannot keep holding on to a poor-performing fund. Even though we reduce tax, sometimes it is better to pay a one-time capital gains tax for a long-term benefit. If we consider the difference in returns between a good-performing fund and a poor-performing fund, it can be huge. To illustrate, the 10-year returns (CAGR) of an average flexi-cap fund stand at a shade over 14.5 per cent, while the bottom performers have returned just around 11 per cent. Underperformance is also a cost, and over long years of investment, it will impact your overall wealth. So, it's better to make changes rather than worry about tax.

It's relatively less painful to make these switches at times when the markets are correcting. The fall in the markets wipes off some of the gains and therefore the cost of cutting the underperformers reduces. Capital gains tax is not avoidable, you will have to pay it at some point in time. So there's no point in running away from it. It also doesn't mean that you go about incurring it recklessly. If you have valid reasons to sell, you shouldn't hold back.

Suggested read: The basics of portfolio-building


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