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ToggleEver heard of the saying ‘Don’t put your eggs in one basket? It basically means diversifying your investments to reduce the risk of investing. But mutual funds already invest in multiple stocks, so isn’t one mutual fund enough to spread your risk? Well, the answer is no. One mutual fund has a little bit of everything but not enough of anything. Hence investing in one mutual fund is not enough. This might lead you to the question, ‘how many mutual funds should I have in my portfolio?’ Read to find out the answer to this and how to build a mutual fund portfolio.
Diversification is a risk management strategy wherein you spread your investments across multiple asset classes to reduce the portfolio’s overall risk. The idea behind diversification is that the risk of an individual security is reduced, and the portfolio will give higher returns in the long term.
So basically, the underperformance of an asset is negated by the good performance of other assets, and the overall portfolio returns will be maintained in the short term. Diversification doesn’t eliminate the market risk, but it tends to reduce it by making your portfolio strong enough to face market volatility.
Diversification is very important when investing in mutual funds. This is because the markets are not stable. Instability in the markets can lead to fluctuations in your portfolio as well.
If one fund isn’t performing well, it doesn’t mean others do too. Diversification works well in mutual funds only if you spread your investments across asset classes and investment styles. This means investing in equity, debt, or gold funds and also ensuring you diversify within the asset class. Take, for example, equity funds. Invest in large, small, and mid-cap, or value and growth funds to reduce your risk of investing in equity.
However, you have to be careful when diversifying. The major risk of diversification is over-diversification. Investing in too many mutual funds can actually harm your portfolio than do you good.
Over-diversification is simply diversifying too much. It happens when each additional asset added to the portfolio reduces overall return greater than risk reduction. In other words, when you over-diversify, you are not benefitting from that additional asset. Instead, you are increasing the portfolio’s risk.
The following are the risks of over-diversification:
Quantum Mutual Fund has introduced the 12-20-80 rule for asset allocation. Using this strategy, you can build a balanced portfolio to earn wealth in the long term and reduce downside volatility in the short term.
There is no right way to build a mutual fund portfolio. This is because every investor is unique and what suits one investor might not suit the other. Hence you shouldn’t run behind top funds just because everyone is investing in them. Instead, you should invest in funds based on your goals and resources. Following are some pointers to keep in mind while building a mutual fund portfolio.
There are several types of mutual funds, and it is important that you invest across all categories to diversify correctly.
So, a total of 5-8 mutual funds are enough to ensure proper diversification. Anything more can lead to an overlap of securities and over-diversification.
It is rightly said, ‘Strength lies in differences, and not in similarities.’ But at the same time, it is important to not over diversify. Over-diversification can only give ordinary results. Strike a balance between risk and return by correctly spreading your investments across asset classes.
Priyanka Rao is a content strategist for Jupiter.Money, and specializes in writing on topics related to finance, banking, budgeting, salary & wages, and other financial matters. She has a passion for creating engaging content that resonates with audiences across various digital platforms. In her free time, Priyanka enjoys traveling and reading, which allows her to gain new perspectives and inspiration for her work. With a keen eye for detail and a creative mindset, Priyanka is committed to creating content that connects well with her readers, enhancing their digital experiences.
View all postsVivek Agarwal is a dynamic leader with deep expertise in investment platforms and wealth management. At Jupiter Money, he spearheaded the Investments vertical, building in-house solutions for direct mutual funds, digital gold, and fixed deposits, scaling the platform to over 200,000 customers. He was an early adopter of SEBI’s Execution-Only Platform (Category 1) and managed key operational, compliance, and customer service functions. Previously, Vivek co-founded Upwardly, a robo-advisory wealth management platform offering tailored investment and insurance solutions. As Chief Investment Officer, he pioneered dynamic asset allocation, goal-based investments, and motif-based portfolios. After Upwardly's merger with Scripbox, he led the integration of independent financial advisors into Scripbox, transitioning assets under management and customer relationships seamlessly. His strategic leadership extended to setting up corporate treasury services for startups and MSMEs, and establishing verticals in insurance and bond sales, including Sovereign Gold Bonds. Vivek’s diverse experience and strategic vision continue to shape the financial services landscape in India.
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