When you invest in only one particular asset – stock, gold, mutual fund, fixed income instruments – you are taking too much risk by concentrating your portfolio. And this risk can be reduced by diversification. That is, you invest partially in all the above categories as per your risk profile so that when one investment tanks, the others can cushion that risk.
For example, in March 2020 and the period after that when 60% of returns were wiped out from our mutual funds, the only investment that could save the day was gold. A portfolio with the right diversification across asset classes makes sure the swing in your returns is kept to the minimum and you have a stress-free investing experience.
Now, this logic is true even for your mutual fund portfolio. One should invest in different types of funds to make sure that the portfolio is finely diversified. But there are often two mistakes that the investors make:
1) Adding sorts of funds to the portfolio
2) Buying too many funds in the same category
Regarding the first point, Shweta Jain, certified financial planner, founder, Investography, and author, My Conversations with Money, said: For most investors, being in every category of mutual funds becomes a fad. It isn’t important to add every type of scheme to your portfolio. Choose your risk profile and time horizon based on which, choose the type of scheme you want to invest in.
Then there is the second category of investors who thinks that if they invest in 10 to 15 equity funds (or any other fund category) or even more, then they are diversified. That is not diversification because the asset class is still the same – equity (or fund category you chose). Diversification is investing in 4 different ways that will work differently. The same logic of portfolio diversification works here.
When the one asset class works, the other may not work, then when the third works, the fourth may not work.
So how many funds should one have in one’s portfolio:
And ideal count in any portfolio is about 8 schemes, where you have different kinds of equity and debt funds. Also, ensure there is real diversification in your schemes and not just the same mandate with different fund names, Shweta said.
And explaining this further, Kalpen Parekh, President, DSP Investment managers, said: My opinion changes on this from time to time but as for a basic portfolio I would suggest four categories: Indian equity funds, global equity funds, balanced funds, and some fixed income instruments. And in each category, you should have two funds.
Shweta adds: If you are a first-time investor then start with large-cap and safe bond funds.