🪄How many mutual funds should you have in your portfolio
When building a mutual fund portfolio, it's common to wonder how many funds you should include. Is it better to spread your investment across multiple funds, or should you keep your portfolio more concentrated? Today, I'll share an example to illustrate why having too many mutual funds might not be as beneficial as it seems.
A Real-Life Example
Recently, I reviewed a portfolio worth ₹50 lakhs. The investment was spread across 20 mutual funds, including allocations to 9 new fund offers (NFOs).
The Performance of NFOs
New fund offers (NFOs) often deliver good returns in their first 1-2 years. This was true for the NFOs in the portfolio I reviewed. They performed well initially, providing a boost to the overall returns. However, this wasn't the case for the other funds in the portfolio.
The Problem with Too Many Funds
The other funds in the portfolio delivered poor returns compared to the index. When I compared the portfolio's overall returns to the Nifty 500 TRI (Total Return Index), I found that the returns were roughly equal to those of the Nifty 500 index.
This means that despite holding 20 different funds, the investor could have achieved the same returns by simply investing in the Nifty 500 index. This raises an important question: is it really beneficial to hold so many funds?
Understanding the Impact of Over-Diversification
1. Diminishing Returns
Having too many funds in your portfolio can lead to over-diversification. When you spread your investments too thin, the impact of any single fund's performance diminishes. In the end, your portfolio's returns may just mirror the market index or lower in many cases.
2. Increased Complexity
Managing a large number of mutual funds can be complex and time-consuming. Tracking the performance, fees, and risk of each fund requires significant effort. This can be overwhelming, especially for individual investors who may not have the time or resources to manage such a large portfolio effectively.
3. Higher Costs
Each mutual fund comes with its own set of fees and expenses. Holding too many funds can increase the overall cost of your portfolio, eating into your returns. Consolidating your investments into fewer, well-chosen funds can help reduce these costs.
Finding the Right Balance
The key to a successful mutual fund portfolio is finding the right balance. Here are some tips to help you decide how many funds to include:
1. Diversify Across Asset Classes
Ensure that your portfolio is diversified across different asset classes, such as equities, bonds, and international funds. This helps spread risk without the need for an excessive number of funds.
2. Focus on Quality
Choose high-quality funds with a strong track record of performance. It's better to have a smaller number of well-performing funds than a large number of average ones.
3. Consider Your Investment Goals
Your investment goals and risk tolerance should guide your fund selection. Ensure that each fund in your portfolio serves a specific purpose and aligns with your overall strategy.
Conclusion
In conclusion, more mutual funds don't necessarily mean higher returns. Over-diversification can lead to complexity, higher costs, and returns that simply mirror the market index. By focusing on quality and ensuring diversification across asset classes, you can build a more effective and manageable portfolio that aligns with your investment goals.
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