Mutual funds pull money from various investors and invest the same into different instruments such as stocks, bonds, etc. In return, investors get the units of a mutual fund which helps them get the benefit of diversification in their portfolio.
But while investing in mutual funds, you might come across a question: how many mutual funds should you invest in? Well, read this article to get your answer.
What is Diversification in Mutual Funds?
There are different types of mutual funds such as equity funds, debt funds, and hybrid funds. Each mutual fund provides different risk-return benefits to your overall portfolio.
Equity mutual funds invest in different stocks which helps in earning above-average returns but comes with a higher risk. Debt mutual funds are relatively safer as they invest the corpus into government bonds, corporate debt instruments, etc.
In the same way, hybrid funds provide a feature of both debt and equity funds and invest the corpus in stocks and bonds in different percentages.
Based on your existing portfolio and your long-term goals and risk appetite, you can select different mutual funds to diversify your portfolio.
Example of Diversification in Mutual Funds
The example of diversification in mutual funds can be understood as a fact that different types of mutual funds invest in different asset classes.
Here is a table showing asset allocation done by different types of mutual funds:
| Equity Fund | Debt Fund | Hybrid Fund | |
| Name of the Fund | Nippon India Large Cap Fund | Aditya Birla Sun Life Medium Term Plan | ICICI Prudential Equity & Debt Fund |
| Type of Fund | Large Cap Fund | Medium Duration Fund | Aggressive Hybrid Fund |
| Asset Allocation | Invest 82.06% in large-cap stocks such as HDFC Bank, ICICI Bank, Reliance Industries, etc. | Invest 40.8% in GOI securities and 40.64% in debentures. | Invest 69.17% in equity instruments and 21.88% in debt instruments. |
Why Should You Diversify Your Portfolio?
Diversification of a portfolio means spreading the risk of losing the invested capital by investing in different instruments. The lower correlation between different types of asset classes minimizes the chance of losing money.
If returns from the equity instruments are falling, debt instruments can give stable returns. This means your portfolio’s risk-adjusted rate of return will increase.
You can also reduce the unsystematic risk with the help of diversification. Unsystematic risk is related to a specific instrument that can be analyzed and reduced by adding different categories of mutual funds.
Problem of Over-Diversifying
While investing in mutual funds, ensure that your portfolio is not over-diversified. It can happen when you invest too much in the same category of mutual funds. Diversification helps in reducing the risk, but over-diversifying can reduce the total returns.
If you invest in mutual funds from the same category that have the same underlying stocks, your returns can fall drastically if the specific category is falling.
With over-diversification, your chances of earning returns in a highly volatile market can be reduced and losses can also be maximized. Also, it is tough to manage and analyze a portfolio that has too many mutual funds or stocks.
How Many Mutual Funds Should You Invest In?
Let’s finally find out an answer about how many mutual funds should I invest in. Well, there is no particular number to this.
The idea is to invest in mutual funds in such a way that the underlying asset holdings do not overlap. Suppose you invest in two large-cap funds then there are chances that the underlying stock holdings of these two funds can almost be the same. You can diversify here by investing in one fund that has exposure to large-cap and another fund that includes small-cap stocks.
Try to invest in mutual funds of different types or categories so that the underlying asset holdings do not remain the same. At the same time, the risk and returns in your overall portfolio also balance out perfectly. Lastly, do keep your investment goals in mind before deciding the perfect number.
Conclusion
Mutual funds allow you to diversify your portfolio with different types of instruments. You can invest in different mutual funds keeping in mind that they invest in a diverse range of underlying assets. This will help you avoid the problem of over-diversification and you can also minimize the risk of losing money.
FAQs
Is it good to have 5 mutual funds?
Yes, it is good to have 5 mutual funds in your portfolio if you are diversifying it into different types as per your investment goals.
Is it good to have 4 mutual funds?
Though 4 mutual funds are fewer. However, if they suit your investment goals and risk appetite, they can help you achieve your goals.
Is it worth investing in multiple mutual funds?
Yes, it is good to invest in multiple mutual funds so that you can capture different asset classes in your portfolio.
How much should you invest in mutual funds?
The amount that you invest in mutual funds is totally dependent on whether you want to invest for the long term or the short term. It also depends on how you want to invest such as through SIP or lumpsum.
📌 You can also read:
- How to Choose Mutual Funds?
- 10 Best SIPs for 3 Years Investment
- 10 Best SIPs for 1 Year
- Best ELSS Funds to Invest in 2024
Happy Investing 💰
Note: This blog is not to be construed as investment advice. Please do your own due diligence when investing in mutual funds. The mutual funds mentioned above are examples, not recommendations.
