Here we explain the rationale behind the number of funds that Value Research recommends for a portfolio
23-Dec-2022 •Sneha Suri
You recommend four or five funds for a portfolio. Does it include both debt fund and equity fund or does it depend on the amount invested or you refer four or five equity funds only? - Hemant Bhatt
There is no rigid rule to recommend a certain number of funds. Also, there is no one scientifically derived precise number of funds that one can have. The rationale for investing in more funds is to diversify. This helps in offsetting the risk of some of the investments turning bad or performing poorly.
But there is no merit in continuing to add more funds in your portfolio beyond a certain point when you don't get much benefit out of diversification.
How much is too much?
Four or five funds are good enough for diversification. This is as per an elaborate study which we did sometime back. The study suggested that beyond four or five funds, typically in the case of equity, you don't get any meaningful benefit out of diversification in terms of reduced volatility.
Having said that, we'd suggest that you think of this aspect from the lens of your goals. As long as you have reasonable diversity in the number of funds for different goals, it is good enough.
Let's understand with an example
Let's say a person has three different goals to be achieved in the next one year, next two-three years and next 15 years. Such goals with different time frames would require a very different set of investments. Therefore if this person has 10-12 funds, they may not be too many considering all the three goals.
In contrast, if someone has three different goals, all to be achieved over the long term, say, in the next five years (single time frame), then a portfolio of more than 10 funds would be too many.
Your goal will have an important role to play in determining the number of funds that are good enough for your portfolio. So, have a goal-based investing mindset, and you'll probably be able to make a better sense of diversification.
Suggested read: Diversify or be defenceless