Diversification is not about the number of funds, it is about how well it is spread across companies and sectors
A frequent question posted to us is about how many funds one must have in their portfolio for optimum diversification. It is encouraging to get such queries, because diversification is the most valuable quality that mutual funds bring to your investments. Simply put, diversification is the practice of including a variety of securities so that in case of poor show of the economy it would not affect all of them and in the process limit the impact on the return on your investments.
When it comes to investing in mutual funds, the biggest advantage is the inherent diversification that is offered by them. By investing a few hundred rupees, you can access a diversified portfolio and at the same time contain the investment risk. As mutual funds invest in stocks of different companies across sectors and market capitalisation, you automatically get the desired diversification.
Diversified fund
In most well diversified funds, the spread is across different companies, sectors and market capitalisation, which provides an optimum allocation and manages the risk well. Considering an equity diversified fund will offer such a spread, an investment in a single fund will also be just fine. Yet, you should invest in more than one fund to get a flavour of the approach used by different fund managers when it comes to the way they manage the fund, which adds to the diversification.
Ideally you should have different portfolios for different financial goals and each portfolio can have a 2-3 funds at best for the desired diversification. There is no proof that having more funds in a portfolio will provide any different or additional diversification. When analysing the holdings of diversified equity funds, chances are that you will find a lot of overlap in their portfolios – the universe of stocks that they invest in. So, if you invest in many numbers of funds, you will be effectively adding more funds with similar investment universe.
Optimum number
Too many funds in a portfolio tend to result in inconvenience, thereby taking away the entire ease of investing that mutual funds stand for. Further, keeping track of several funds in your portfolio will only add to frequent reviews and analysis, which can be cumbersome. Make investing easy by investing in SIPs of mutual funds. Many a times, more number of funds in a portfolio gets added because of a push from a distributor. Do not succumb to such pressures and stick to your need with 3-4 funds at best and no more. Ensure you track the performance of these at least once a year and review its role in your portfolio.