Here we tell you the importance of diversification and how to build a diversified mutual fund portfolio
Can we have only one mutual fund, preferably flexi cap, in our portfolio? As mutual fund portfolio itself contains at least 20 to 30 companies, which I think is fair diversification. So why increase the number of funds in our portfolio? - Alok Joshi
Keeping an eye out and tracking several mutual fund schemes in your portfolio can be tiring and time consuming.
Does that mean you should limit the number of mutual fund schemes in your portfolio to just one? No.
Diversification is one of the most important elements when it comes to investing. As the saying goes, 'Don't put all your eggs in one basket' - concentrating all your resources on just one investment can be risky. What if the investment doesn't perform as expected? What if it turns out to be a disaster?
Diversification will reduce the risk by spreading the investment across funds - keeping the eggs in different baskets.
How diversification helps?
The idea of diversification is straightforward. Stocks of different kinds of companies tend to do well or badly at different times. By 'different types of companies' one could mean companies from different sectors, different parts of the world, or with varying financial parameters, like different levels of interest cost or forex exposure.
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. A mutual fund already does this and for the investor who is putting his money in funds, the only diversification that is needed is in terms of different fund managers.
But why different fund managers?
Yes, you do achieve enough diversification when a mutual fund invests across 20 to 30 stocks. But you're still leaning towards the investment calls, judgement and investing style of just one fund manager - making the investment risky.
Even if you go ahead and invest in a different fund of the same fund house, there is a possibility that the investing style would remain the same. So it is essential to invest across fund houses and different managers.
In our judgement, four or five funds are enough to provide this kind of diversification. Any number beyond that will provide no additional diversification or reduce the risk. Additionally, investing in too many funds takes away the major attraction of investing in mutual funds in the first place, which is convenience.
Quality over quantity
Your returns are driven by the quality of your selection, not quantity. Investing in too few funds might concentrate your portfolio and having to keep track of a large number of mutual funds simply adds to your work. What you do need to ensure is that the small number of funds that you own should be of different types and managed by different fund managers.
This is good enough to achieve diversification.
Suggested read: How many funds are needed to achieve adequate diversification?