Often investors fail to get the desired returns from their mutual fund investments, and one of the reasons behind this is the holding of too many funds.
By now, mutual funds have established themselves as the go-to asset class to build wealth for various life goals. Helping you diversify your portfolio, they help you achieve various short and long-term goals with ease.
However, often investors fail to get the desired returns from their mutual fund investments, and one of the reasons behind this is the holding of too many funds.
The Problem of Plenty
It’s very common for investors to hold several funds of similar types in their portfolios. They do it for the sake of diversification, believing that it will down risk and enhance returns. However, more often than not, the opposite happens.
When you hold too many funds of similar nature with core fundamentals remaining the same, it dilutes returns. The losses and gains are cancelled out. The profits from high performing schemes get compromised by the losses from low-performing ones.
Also, every equity fund that you own invests in at least 50 to 60 stocks. If you hold 8 to 10 equity funds, you invest in 400 to 600 stocks or even more. In such a scenario, your portfolio, in reality, would act as a tracker fund. It’s tough to generate alpha if you end up owning the entire market.
If you want to do so, it’s better to invest in an index fund. You can not only save on costs but also get over shocks related to your fund’s underperformance.
Difficult to Monitor
There’s another problem when you end up holding too many funds in your portfolio. When you do so, it becomes bloated and difficult to monitor. It takes more time than required, and you may not be much inclined to review your portfolio even once a year.
If you are not sure how much each component is performing, then there are chances of chronic underperformers escaping the scrutiny net and dragging down returns.
The Way to Do It
So, what’s the right approach towards diversifying without holding too many funds in your portfolio? You must focus on the right fund in the right proportion. At the same time, you must regularly rebalance your portfolio to identify laggards and weed them out.
The right asset allocation would not only prevent you from going overboard but also prevent the gains from eroding in case markets nosedive. For instance, during the market carnage in March 2020, when equity funds wilted under mass selloffs, portfolios that were exposed to gold and debt remained resilient.
The Number of Funds to Hold
So, how many funds should you hold in your portfolio? When it comes to equity funds, investors are spoilt for choice. With large-cap, mid-cap, multi-cap and small-cap funds to choose from, the choice can be overwhelming.
However, at any given time, three or four funds should do the job for you. A couple of multi-cap funds, along with a large and mid-cap fund, should do the job for you. If you have a high-risk appetite, then you can choose a small-cap fund. Don’t stretch further.
Also, make sure that the funds you choose don’t end up holding the same stocks as overlapping will not do any good. In the case of debt funds, liquid funds should be a part of your portfolio for building an emergency corpus.
Summing it Up
As evident, by limiting the number of funds in your portfolio, you achieve diversification and ensure optimum returns. Regardless of the size, three to four funds are enough to make a well-rounded portfolio to enhance your riches.
To avoid overlapping, analyse the funds’ portfolios minutely. Have a close look at the composition of funds and use online tools to determine the extent of overlap.
(By Rahul Jain, EVP & Head, Edelweiss Personal Wealth)