This article will share the downside of investing in too many mutual fund schemes and how to create a focused mutual fund portfolio.
Purpose of investing in mutual funds
This means that some stocks will go up in a given market, and some will come down. And this will help you earn a stable average return from your portfolio. This is a much better strategy than always in a roller coaster ride, swinging between safety and returns.
When you invest in a single mutual fund, realize that you are already diversifying your money. So, any further diversification by adding a new scheme should be for the right reasons.
Why people end up investing in too many MF schemes
- Lack of proper knowledge of mutual fund selection can cause a lack of conviction in your fund choices. You may feel that at least some good-performing schemes will offset the loss in other schemes. This, frankly, is not a very wise approach.
- The ill-assumption that investing in all top-rated funds available in the market will guarantee that the portfolio as a whole will perform better. Little you know that today’s top performer is a laggard in the next year.
- Giving in to marketing gimmicks and buying every new fund offer that comes across (NFO)
- Seeking advice from unscrupulous financial advisors who invest your money in a large number of schemes to command a higher fee from you.
Side effects of having too many funds in your portfolio
- Over time, the low-performing funds will bring down the returns of your entire portfolio
- You can face difficulty in managing the portfolio – this can also result in low-performing funds sitting for long periods in your portfolio and draining the returns
- Investing in new funds without thoughtful effort in the investment style of the fund can cause the portfolio to tilt towards a specific style – this can cause losses during sharp one-way movement of markets
- Moving out of schemes can cause avoidable tax implications
- Consolidating the portfolio at a later date can be too much of a pain and make you procrastinate – also, doing so can cause unnecessary tax implications
So, how many schemes should you have in your mutual fund portfolio
- The stage you are in your financial journey at this moment
- The nature of your financial goals
- Your preferred asset allocation
- How much money you plan to invest or your total investment in mutual funds
Suppose you are a beginner investor and want to start by investing, say, INR 5.000 per month. In that case, you can start a SIP in, say, 2 large-cap mutual funds, or you can have combinations such as one large-cap and one index fund or one large-cap and one ELSS fund and so on.
As your savings grow, you can diversify into more schemes and asset classes. This will help reduce fund manager risk, and you also gain the benefit of asset allocation. So, you can consider adding one liquid fund, one gold fund and one multi-cap equity fund.
And then, as your savings and wealth grow even further and you start doing goal-based financial planning, you need to further refine your approach. It is here that hiring a financial adviser makes sense. You can add an international fund to diversify the geographical risk.
Overall, if you are a middle-class family with a reasonable investment corpus, around six to eight schemes can suffice all your requirements.
Some additional tips for young investors
- Instead of blindly adding schemes, try to diversify between various investment styles and strategies (e.g., growth/value, large-cap/multi-cap), keeping in mind your financial goals
- Diversify across stocks but also diversify between asset classes.
- Even between the same investment style, try and spread the investment between multiple fund houses to diversify fund manager risk.
- It is perfectly ok to invest in one scheme for different goals. For ease of tagging and tracking goal progress, you can invest in multiple folios of a scheme.
- Stay away from New Fund Offers. If your adviser asks you to buy a new scheme, ask him how the new fund fits your overall portfolio and replace which existing scheme. If your adviser cannot give a convincing answer, don’t proceed.