Diversification is nowadays the key objective of making mutual fund investments. It is a very crucial element in order to stabilize your portfolio. Diversification can be well explained with the example of an organization. Take up any organization, company or establishment, you will rarely find one with only male employees or female employees or only youngsters or people of a certain community. The organization is always a mix of gender, communities, age group, etc. This is because to run an organization successfully, there is a need for a set of skills which different people possess in different levels of expertise.
Same is the case with mutual fund investments, with the fluctuations that the market goes through and brings about the volatility, the funds at stake become vulnerable. Hence in order to stabilize the performance of your portfolio and help in risk mitigation, there can be many ways you can diversify the portfolio but we at Piggy believe that the best diversification is through investing in mutual funds. Let us see how;
What is the need for diversification?
There is no such thing as a risk-free investment, be it gold or real estate or stocks. If you have invested all your funds in a single type and that happens to perform badly, you might be up for a steady loss. Not only the loss is the concern but also your long-term financial goals. A little disruption can be borne but a huge loss does breakdown the confidence of a man.
Diversification is a method of spreading funds across different segments. It reduces the overall risk that hovers over your investments and provides with opportunities which you were otherwise unaware of or reluctant to explore.
Mutual funds and diversification
Mutual funds are the best and most convenient way to diversify your portfolio. Mutual funds provide with best asset allocation without the need for in-depth knowledge about the assets. Market corrections happening at macroeconomic levels do not affect the portfolio adversely. So, which asset type to choose from the variety? Have a look;
Equity mutual funds
These are the funds which make investments majorly in the equity market. There are options available from which you can choose like large-cap funds, mid-cap funds, and small-cap funds. It is always advisable to go for a combination of these. Also, be diligent about choosing funds which have stocks in different asset classes and across different industries. The deciding factors should be your risk appetite and investment or financial goals.
Debt mutual funds
Debt funds invest in debt securities like money market instruments, corporate bonds, treasury bills, etc. Debt funds generally yield better returns than the traditional instruments like FDs in the long run. If you hold your debt funds for more than 3 years, then you will also enjoy good tax-benefit.
Balanced mutual funds
Balanced mutual funds or hybrid mutual funds are a mixture of both debt and equity funds. Hybrid funds are best suited for novice investors wishing to avoid equity-market risks. The debt funds portion provides cushioning over the risks to a great extent.
What is the right number of funds which ensures diversification?
How many funds should I go for to diversify my portfolio? Or what is the diversification threshold number? Or how many funds to diversify my portfolio? These are the most commonly asked questions related to diversification by investors. There is no fixed answer to this question. It is different for all investors as the deciding factors are disposable income, risk appetite, and investment goals. Ideally, 3-5 equity funds are sufficient in a diversified portfolio, more equity funds will attract larger risks. Also, these funds should be across different segments of the market.
One important point here is to keep a check on the number. Yes, diversification simplifies things and spreads out the risk but too much of everything is not good. Make sure you do not land up investing in a large number of funds which will increase the complexity of managing your portfolio. Also, there are a certain number of options available in the market. If you have 15 funds in your portfolio that means more or less there is a repetition in the type of funds. Repeating the fund type nullifies the whole essence of diversification. In our opinion, having 4-5 funds in a portfolio is the ideal number to enjoy the benefits of diversification.
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