With innumerable mutual fund investment options available in the market right now, it is hard for a newcomer to decide which mutual fund is better than the other. While its is a better option to invest in two or three different mutual funds, investing in more than four mutual funds is not only unnecessary , it may not even give you negative results instead.
But investing in multiple mutual funds gives you more diversity and returns, right ?
the truth is that no additional diversification is provided by investing in more funds beyond a certain point. Mutual funds are not an investment by themselves. They are a way of holding the underlying investments which, for equity funds, are stocks. The reason why too much diversification is pointless is that the stocks held by similar funds tend to be a similar set. Beyond a small number, when you add more funds, you are generally adding more stocks that are similar or identical to what you already have.
Diversification saves your from poor performance of a set of investments. If a particular company or sector does worse than the markets in general, then having only a small part of your money exposed to it helps. Diversification could also be across company sizes as sometimes only smaller or larger companies do well or badly. It could also be geographical. Diversification does nothing for you when the entire market declines.
Having too many funds in one’s investment portfolio devalues one major advantage of investing in mutual funds, which is convenience of tracking and evaluating one’s investments. Have investments in a large number of mutual funds makes this exponentially more difficult. Periodically, perhaps once a quarter, investors should evaluate each fund in their portfolio and see if it’s contributing what it’s supposed to. However, when you have 15 or 20 funds, this exercise is impossible.
It’s hard to work towards meeting your financial goals when you can’t evaluate and manage your portfolio because it’s bloated. The ideal number of funds tends to be three or four, anything more is a waste of effort. In fact, depending on the size of someone’s investments, it could be even less. For someone investing perhaps five or six thousand rupees a month, one or two balanced funds are ideal and anything more than that is pointless. Remember, mutual funds themselves encapsulate diversification, while adding more funds gives very little returns
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