All you need to know about diversification in Mutual Funds

Whenever somebody talks about Diversification, he will always be able to recall a pearl of wisdom which says, ‘Don’t put all your eggs in one basket’. However, nobody tells you how many baskets you should have! This is akin to asking, “How many Mutual funds you should have in your portfolio”?

Imagine an investor A having 10-20 individual stocks & another investor B having a mutual Fund which tracks the S&P 500, which includes over 50 stocks. The investor B faces less risk as compared to investor A where he is able to diversify into many different stocks in a simpler and more cost-effective way. The example of Investor B explains the diversification strategy.

Consider another example, where the investor A has a portfolio of Mutual Funds. His portfolio has 3 Mutual Funds whose holdings are in financial sector only. Another investor B has a portfolio of 3 Mutual Funds, each of which has holdings across sectors like Real Estate, Finance, and Commodities. The investment of Investor B is more diversified than A & hence safer.

Diversification reduces the risk of your investment and at the same time offers broader exposure to various stocks & sectors.

Since Mutual Funds have diverse holdings, you get the benefit of instant diversification when you invest in a Mutual Fund. Secondly, by investing in wide varieties of Mutual funds, you get the benefit of portfolio diversification into multiple fund categories. Diversification allows you to minimize the risks & reduce volatility associated with your investments, thus building your wealth over time.

Investing in mutual funds also allows for diversification between various styles, sectors, countries, or any combination of security types. This way you as an investor can buy a broadly diversified Mutual Fund or you have the option of building a portfolio of mutual funds across categories & sectors. So, you can opt for either instant diversification or create your own diversification.

When you are building your own portfolio take care that you don’t invest in similar types of Mutual Funds with same underlying holdings. You should spread your money by investing in different categories of Mutual Funds. This is how you should diversify your portfolio. But, how many mutual funds you should have in your portfolio? The number of Mutual Funds in your portfolio depends on a number of factors.

1. Your Investment Objective

• Investment Objective determines what particular asset classes and security types you would like in our portfolio.

2. Your Risk Tolerance

• If you have a high-risk appetite & have invested in Equity, it is advisable to invest in not less than 3-4 Equity Funds.

3. Your Preferred Categories & Types

• You can invest in Equity, Bond, money market funds etc or a mix of multiple categories.

4. Your Investible Corpus

• You can start investments with SIP as low as Rs 100. If you want to invest Rs 2000 via SIP, you can invest in 4 Mutual Funds with a SIP of Rs 500.

5. Your Portfolio Building Strategy

• You are wise enough to construct your Portfolio, according to your needs. You are also free to contact your Financial Advisor, who is always there to help you.

The ideal number of Mutual Funds in your portfolio should lie in between 3-5. In extreme case, you can build a portfolio of up to 10 Mutual Funds. However, you should avoid having more than 10 Mutual Funds in any case.

The best way to reap the benefits of Diversification is to get in touch with the Financial Advisor. His or Her Professional advice will surely help you achieve financial objectives.