Having funds of different market capitalisations and investing styles would provide adequate diversification across assets, sectors and stocks.
If you are investing in mutual funds you might be faced with the dilemma of how many schemes you should ideally invest in? While there might not be a magic number for schemes one should invest in, most financial planners and investment advisors would tell you to have a diversified portfolio and not to concentrate your bets on a single scheme. Investing in one scheme can be risk prone.
“Many investors, especially those new to mutual funds, tend to invest their entire surplus in just one mutual fund scheme. This concentrates their investment risk with just one fund management team. Moreover, investing in a single fund might not generate optimal returns as funds that deliver outstanding returns in the long term may deliver lower or negative returns in the short term, and vice versa,” said Manish Kothari – Head of Mutual Funds, Paisabazaar.com.
Ajit Narasimhan, Category Head – Savings & Investments, BankBazaar.com also said that investing in only one scheme will increase exposure risk. To mitigate this, it's best to diversify across 3-4 schemes. It's similar to the theory of hedging one's exposure across multiple investments. “Having funds of different market capitalisations and investing styles would provide adequate diversification across assets, sectors and stocks,” he said.
Diversification basically means investing in a variety of securities so that a failure in a security or an economic slump affecting one of them will not be damaging to your portfolio. In easy terms, it basically means to spread your portfolio in different types of stocks, bonds, assets, etc. While professionals find it easy to diversify their funds across asset classes, an individual investor often finds it difficult to choose asset classes themselves. Hence, it is better to put the money into a mutual fund where the fund manager handles their tension for a small fee.
Abhinav Angirish, Managing Director, Abchlor Investment Advisor said that while mutual funds are a great tool for diversification, many investors think that once they put their money into a mutual fund their work is over, but for a fact this is not the case, their work just starts as even in mutual funds sufficient diversification is required. For example You may invest in 4 different mutual funds, but it does no good if they all have similar holdings, that is a portfolio which is highly correlated with each other. In this case, you are not actually diversifying because if something affects the securities in one fund, it will also affect the other fund. In this case, you will be holding the same amount of risk which a single fund would have to your portfolio, which in proper diversification can be reduced.
“If you want to truly diversify your portfolio, then you need to invest in mutual funds that are not correlated to each other in performance. You can do this by considering which asset holdings your current fund has and based on that try to spread your money so that no asset with similar features are repeated in your next fund,” he added.
You should always remember that the diversification towards any investment should be done in exactly the way it demands in a said particular situation. Doing too much of diversification will also not serve any great purpose because the stocks present in different-different schemes will be more or less similar. However, the performance of schemes varies as it depends on the call taken by respective fund managers holding their particular schemes.Hence, it is advisable to take adviser’s help before taking any step of doing investments in mutual funds.