Mutual funds are a popular vehicle for wealth creation but a question among investors is: What is the ideal number one should one hold?
“Diversification is essential for enhancing portfolio performance and stability. For instance, an investor who allocates all his funds to a single large-cap fund from one AMC (asset management company) may inadvertently increase concentration risk, as all market capitalisations tend to experience cyclical performance,” said Chirag Muni, executive director at Anand Rathi Wealth Limited.
“Consequently, the overall portfolio would be heavily impacted by the performance of that single fund and increase the concentration risk associated with that particular market cap and AMC performance,” he said.
While diversification is crucial, holding too many mutual funds can also lead to issues such as:
Overlap in holdings, negating diversification benefits.
Difficulty in monitoring and rebalancing the portfolio.
Higher expense ratios eating into overall returns.
Potential for returns to mirror index performance, defeating the purpose of active fund management.
Ideal number of funds
Investment goals: Long-term wealth creation may require a different approach compared to short-term objectives.
Risk tolerance: Conservative investors might lean towards a higher number of funds to spread risk, while aggressive investors might concentrate on fewer high-potential funds.
Investment amount: Larger portfolios can accommodate more funds without sacrificing meaningful allocation to each.
Market segments: Exposure to different sectors, market capitalisation, and geographical regions may necessitate additional funds.
How to enhance portfolio performance
“To enhance portfolio performance, investors should adopt a multi-tiered approach to diversification. At the initial stage, diversification should begin with allocating investments across the asset classes, equity and debt, within mutual funds. Moving ahead, investment involves spreading equity investments across various market capitalisations, including large, mid, and small cap,” said Chirag.
He recommended diversifying investments across categories such as multicap, flexicap, value and contra. Schemes should be spread across different AMCs too. “This comprehensive process effectively mitigates concentration risk, enabling investors to maintain a well-diversified portfolio, ideally composed of 10 to 12 schemes.”
First Published: Sep 11 2024 | 5:18 PM IST
