Like so many other favorites in life, mutual funds are also confusing to choose from. With more than 300 different options available, picking up 5 to 7 best funds is like finding a rice grain in the wheat sack. To make it all the more difficult, the confusion does not end at picking up the right stocks but knowing when to stop. What if you have 10-12 different funds in your ‘well-diversified’ portfolio and all of them are good performers? Now that you have already crossed the limit that suits best a diversified portfolio, how will decide which fund to chunk and which ones to keep?
Here are key insights into the concept of over-diversification
- Do not duplicate what you already have at hand
Generally, an equity diversified portfolio has around 30-70 stocks from different companies across different sectors. These are usually those funds which have a higher allocation on indices which are benchmarks like Sensex and Nifty. These funds are spread across different market capitalization like large-cap funds, multi-cap funds and large-mid-cap funds but show one common feature- overlap.
Post the SEBI rules and instructions on various categories, the chances of landing onto similar stocks is even more. They may differ in stock weights but overlapping will happen.
It is advisable that you possess between 4 to 8 different equity funds which are laid on varied foundation grounds. These funds may be different in terms of strategy, vision, market cap etc. and have minimal overlap. More importantly, these funds must fall in alignment with your long-term goals.
If these things are taken care of, your portfolio will be diversified to a justifiable extent and would serve as an aid in your long-term growth.
- More than good, it can do bad to your portfolio
The overall performance of a portfolio is determined by the performance of each fund you have. no single fund or stock can lead your portfolio to heights. Before you invest, have a look at the long term or historical data of these funds you are targeting and then pick from these funds.
Holding too many funds in your portfolio can bring down the overall performance of your portfolio or in other terms, the overall average returns. It is better that you stick to a few choicest funds rather than stuffing your portfolio with overlapping funds. These consistent performers will prove to be more beneficial than a mediocre-performing lot.
Diversification is a concept only a few deeply understand. The fundamental purpose of it is to spread the risk across different fund types in your portfolio. But this too has a capping, excess of diversification can act oppositely and reduce your overall returns. Adding too many funds together can increase the risk of having too many under-performers at any point in time. Plus, investing in overlapping or similar funds means you are doing no value addition to your portfolio.
Next time, an NFO comes out in the market or some new fund tempts you, think about the health of your portfolio.