Diversification in mutual funds

Diversification in mutual funds

Diversification is one of the most common terms used with respect to investments. Diversification is the ideal method to mitigate risks and allow your portfolio to perform better. In general, if you diversify your investment, it reduce your overall risk of investment. You can reduce this risk by investing across multiple asset classes. These asset classes could be mutual fund, real estate, fixed deposit, recurring deposit etc..
Exm- If you have 3 Lac rs, then you can invest 1 Lac in Mutual fund, 1 Lac in real estate and another in FD.

Now why should you diversify your investment in asset classes ?
The answer is, if one asset class doesn't do well, the others will do well. And so your overall portfolio returns would not affect.
Now come back to mutual funds. Mutual fund is already collection of securities.
In debt funds, it is collection of debt kind of securities. If we talk about equity funds, it is collection of equity stocks. In balaced fund, it is collection of debt as well as equity types of fund. So mutual fund already giving us diversification. There are total of 43 Assets under management (AUMs) of mutual funds in India. (Birla Sun Life Asset Management Company ,HDFC Securities,Reliance Securities etc.. ). And total number of mutual fund schemes is over 2599 in India. Now question is How many mutual funds you should have in your portfolio ?

Lets say, you want to invest in large cap funds. Large cap funds are those that invest at least 80% of their asset in equity oriented large cap stock only. Now what is large cap stock ? Large cap stock is top 100 companies in terms of market capitalisation. So when you invest in more than one large cap fund, you will be having portfolio overlapping. Again if you go for third fund, you again having same stocks invested in. It means 3 funds here doesn't provide you better diversification. One fund per category is enough for good diversification.

It means one or two fund per category will provide you good diversification. If you want to invest in five different funds, then don't select all five funds from small cap or large cap or hybrid. You can choose five funds from 5 different asset classes.(One fund from equity, another from debt, another from balance etc..) The ideal number of funds depends on factors like your investable amount, investment goals and risk profile. Investing in a higher number of funds will impair your capability to monitor the funds effectively. Besides, it may also result in repetition of stocks affecting the very basis of diversification. It is worth remembering that diversification is not about numbers, but investing across a range of companies, sectors and assets classes. Too many funds also make it difficult to track your overall portfolio.