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How many mutual funds should a portfolio contain?

Submitted by admin on October 1st, 2024

The frequency of how many of these mutual funds to include in the portfolio, when building a mutual fund portfolio, is again determined relating to optimal diversification and returns. The responses to this question are completely subjective to the intent of individual financial goals, tolerable risk levels, timeline for investment, and the necessity for diversity across various sectors or asset classes. Even as diversification is important to minimize risk, over-diversification may reduce the effect of having several funds in the portfolio. A balanced approach aids the right blend of the portfolio mix.

1. Diversification and Risk

The main reason for holding several mutual funds in one portfolio is for diversification purposes, which would reduce the risk of the portfolio. Each mutual fund holds a number of securities, whereas having several funds reduces your exposure to all of them at once. This in turn then reduces the impact of any poor performance in one of these investments. Ideally, you should seek funds that cover different asset classes, such as equity (stocks), debt (bonds), and hybrid funds that combine both.

2. Avoid Over-Diversification

It is necessary to diversify, but too many mutual funds have an evil tendency of over diversification that reduces returns. Over diversification happens when a portfolio inflates with a huge number of investments in a variety of funds- leading eventually to overlapping investments in similar sectors or stocks. This reduces the overall performance potential of the portfolio, as gains from well-performing funds are offset by laggards. Secondly managing large number of mutual funds becomes cumbersome and increases the complexity involved in monitoring the same portfolio.

3. Asset Class Allocation

Divestiаble assets are diversified only in case if a portfolio includes a variety of funds split up into different classes. According to risk tolerance and level of investment, you might want to select among them some combination of:

• Equity Funds: For growth-oriented investors with a more risk-adjusted appetite, equity funds are the road for large-cap, mid-cap, and small-cap funds. Large-cap funds are stable and consistent in returns while mid-cap and small-cap funds offer a great scope of growth but at higher risk.
• Debt Funds: Debt funds provide stable returns with lesser risk for conservative investors or those who are close to retirement. A debt fund includes government securities and corporate bonds apart from other fixed income instrument and can reduce the volatility of a disciplined equity investment.
• Hybrid Funds: Hybrid funds provide an eye to both, the equity and the debt, acting like a middle ground between pure growth as well as stability.

4. Rebalancing and Monitoring: Adequate funds for your investment portfolio ease its management. Having too many funds makes rebalancing and tracking their performance challenging. A diversified portfolio with 3-5 funds ensures that you monitor each fund’s performance effectively, take correction where necessary, and rebalance to your desired asset allocation.
5. Aligned to Financial Goals

Again, the number of mutual funds in your portfolio must match your financial goals and time frame. For example, if you have a long-term goal such as retirement savings, you might want to be a little more conservative with a higher allocation to debt funds. You may like equity exposure for higher returns if you are young and the time horizon is long enough.

Conclusion

In summary, the number of mutual funds in a portfolio depends on your risk tolerance, financial goals, and comfort with diversification, usually ranging from 3 to 5. Having too few funds may place you at undue risk, whereas too many funds may lead to unnecessary over-diversification, resulting in reduced returns. Thus, only asset class diversification and monitoring would yield a rock-solid, well-balanced portfolio that is aligned with your financial goals.