What to do when your Mutual Fund portfolio is Overdiversified?

What to do when your Mutual Fund portfolio is Overdiversified?

You may have heard the expression "too many cooks spoil the broth" as a child. The same applies to your mutual fund portfolio. Financial pundits often recommend a well-diversified mutual fund portfolio to spread your risk exposures. However, your portfolio doesn't need to be too diverse to reach the over-diversified zone. So how do you know your portfolio is diversified or has tipped towards over-diversification? How many funds should you have? This post will discuss all this and other issues that can affect your mutual fund diversification. Continue reading!

Meaning of portfolio diversification

Portfolio diversification is a strategy that allows you to add mutual funds that invest in different asset classes. This strategy is risk management because you can invest in many assets. Concentrating on one asset can lead to large losses.

Let's say you have Rs 1000 to invest.

On a year-to-date basis, almost all equity mutual funds in different categories are down at least 20%. During the same time period, gold funds have increased by 21%. These data are as of April 28.

Scenario 1: No diversification

Imagine that you had Rs 1000 invested in an equity fund.

After pricing at a 20% discount, the value of an investment as of April 28: Rs 800

Scenario 2: Diversification

Imagine that you have invested Rs 900 in an equity fund and Rs 100 in gold. Experts recommend not exceeding your gold investment by more than 10%.

Equity fund

After pricing in reductions, the value of the investment on April 20, Value of investment: Rs 720

Fund for gold:

After rise in price, April 20, the value of investment: Rs 121

Total Value = Rs 841

If you had diversified, there would be an increase in Rs 41

Why one should diversify his/her portfolio?

The above example may help you understand why mutual fund diversification matters. Building a diverse portfolio of mutual funds is key to reaching your financial goals. 

To spread your risk: Diversification helps you spread your risk among multiple investments, so adverse movements in one or more investments do not have a significant impact on your portfolio returns.

Maximize your returnsSpreading your risk and minimizing it is one way to maximize returns. Concentrated portfolios can also lead to a soup.

You would have lost a lot of money if you had only invested in one asset class during times like these.

A diverse portfolio will help you get better returns over time, and accumulate more money.

To compensate for our weaknesses: When you compare equity and equity, you will see that equity is more volatile and has a higher risk of loss. However, debt funds offer moderate returns but are safer than equity. Each has its advantages and disadvantages. Diversification can help you balance the disadvantages of each with the benefits of the other.

Your chances of losing money are reduced by investing in different types of funds that invest in different asset classes.

Important points to remember about portfolio diversification

There are some things you should be aware of when you're looking at how to diversify mutual fund portfolios and researching strategies and funds as well as other avenues for investing.

Diversification means 'variety':Diversification is only possible if the investments within the portfolio are significantly different from one another. They are not correlated.

Many investors believe that mutual fund investments in a portfolio reduce risk. This is a false assumption.

Multiple investments in mutual funds of the same asset type are not a good idea.

Only covers risk up to a point strong evidence shows that diversification can only be used to reduce the risk of your mutual fund portfolio.

You can achieve optimal diversification by not adding too many mutual funds to the portfolio, but by adding several uncorrelated mutual funds.

Spotify if your mutual fund portfolio isn't performing as expected Overdiversified

Avoid over-diversification. In the spirit of diversification, you might end up in over-diversification. We have your back. This section will help you spot excessive diversification.

Here are some ways to spot over-diversification within your portfolio.

Too many mutual funds in a single category idea behind a diversified mutual fund portfolio is to invest in multiple mutual funds so that you have multiple sources for returns and your portfolio's overall risk is minimized. If you have invested in multiple mutual funds from the same category, it is likely that your mutual fund portfolio has become over-diversified.

Each development or news item can have an important impact on your mutual funds portfolio. - For over-diversification it is an important indicator. Your mutual fund portfolio may be over-diversified if you invest in multiple mutual funds but one news flow or macroeconomic development has a significant impact on your overall mutual funds portfolio.

Over-diversification is a drawback

We have already discussed the benefits of diversification, but we must also consider the downsides.

  1. Monitoring performances: If your portfolio contains more funds than you need, tracking each fund and asset class will be extremely difficult.
  2. Prices Every investment comes with a cost. Pay attention to the fees associated with the funds that you invest in. Over diversification will result in a significant cost burden in the form of additional brokerage fees. Cost ratio management fees for certain funds, etc.

What are the Best Funds for a Diversified Portfolio?

Investors who are interested in diversifying mutual funds face this problem frequently. There is no magic number. There are many factors that influence the optimal number of funds, including your investable amount, investment goals, and risk profile. There is no right number of mutual funds to diversify. Investors can take a few things into consideration when building the best mutual fund portfolio.

  1. To create your mutual fund portfolio, determine the types, themes, strategies, and categories of funds that you would like to invest in.- you can spread your mutual fund investments across asset classes (debt/equity/hybrid), themes (sectoral), and strategy (dynamic/arbitrage), etc.
  2. You should not purchase more than three to four funds from each category. Ensure that you are not too exposed to one category once you have chosen the category. This decision must be made after considering your financial plan. It should also reflect your risk/return profile.
  3. You should ensure that your portfolio is well-diversified. Ensure that there are no overlaps within a given category once the category has been established.

Let's say you want 40% exposure to equities. Now, within equities, it would be wise to invest in mutual funds across Market Capitalization and themes rather than invest in only one type, say large-cap, of the mutual fund. You can have as many as 3-5 equity mutual funds in your portfolio. They are distributed across various market segments and fund management styles.

The Last Word

It is important to remember that diversification does not involve investing in a specific number of companies or sectors. Instead, it involves investing across multiple asset classes using mutual funds.

Do not add funds to your portfolio because a friend recommended it or you read in the news that the fund is doing well. It can be difficult to track their performance, which is an essential activity. There is no set number of mutual funds that can be used to diversify.

You should monitor the performance of your existing funds. If you feel that some funds are not performing well and are weighing down your portfolio, you should stop investing in them.

These may be temporary and return to normal in the next business cycle.

Keep in mind that no matter how diversified your portfolio is, it cannot completely mitigate risk or eliminate the 100%.

Market risks can affect even diversified investments. Keep reviewing your portfolio and the market for mutual funds to make sure you're on track to achieving your financial goals.

Best wishes for investing and good luck for the future!

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