Don’t put all your eggs in one basket! One of the famous quote from veteran investor and billionaire Warren Buffett which is always used by investors to defend their act of investing in multiple mutual funds. Yes, Warren Buffett used this quote to remind the significance of diversification, but I believe which is misunderstood by many of the retail investors.
What should be the ideal number of mutual funds one has to buy? 5, 10, 20, 100? Is there any calculator to throw the numbers? The reality is, there are no such predefined metrics to tell you how many funds you should buy. Before looking into the parameters that need to consider before deciding the number of funds, let’s look into the concept of diversification.
The story of diversification
I met an Investor a day ago and he asked me for a fund suggestion. He told me that he had diversified his portfolio and need some comment on that as well. He believes investing in mutual funds is easy and thus used a direct investment platform. The number of funds in this investor’s portfolio was 11 and he is in his late 20s. He invested in top funds from 11 AMC which is suggested by the investment platform. Now he is looking for the 12th fund from a different AMC. For my question, why you need a fund from a different AMC other than the 11, his answer was simple; “diversification”. This answer made me write this blog.
The primary piece that we need to understand is, a mutual fund doesn’t have any value of its own, and it holds the value of the underlying asset classes. Thus the diversification should be done at the level of asset classes (Equity, debt, FD, gold, real estate). So in mutual funds, depends upon the capital you have, you can invest in stocks of a company from different sectors, debt funds, gold ETFs, etc. This will help to balance the risk-reward.
In India, most of the mutual funds in the same category hold almost similar stocks. There might be a small percentage of difference in the total portfolio holding and individual allocation. Then what makes the difference? Read my previous blog to understand the factor needs to be considered while selecting mutual funds. I believe investors need to look inside and consider the following key factors to choose the number of funds they need to hold.
Investment Goal
Investors should always have a goal before choosing an investment strategy and asset class. Even though the ultimate goal is to beat inflation and create wealth, the goals will help to stay focused. An investor looking for a long term capital appreciation and one who is looking for steady income need to invest in different assets and use different investment strategies to achieve their goals.
The Time Horizon
Time horizon is the period over which you are planning to invest. The nature of the asset class depends upon the time you have. For e.g. If you are investing for a year or two it’s better to keep your money in a debt instrument rather than an equity fund which is subjected to more volatility.
Risk Tolerance
This is your risk-taking ability. As we all know higher returns are associated with higher risk. An investor in his early 20s can invest in smallcap funds as his horizon is long whereas it’s too risky for a retired person to put his retirement amount in a high-risk equity fund.
It is always preferable to have invested in a minimum number of funds. Choose the funds that suit your investment strategy. Make sure that you are investing in a diversified asset class not diversifying the AMC.
Investing is never an easy job even though it’s simple. Always understand the risk before investing. You need to put a lot of effort into setting up a portfolio that can create wealth. We will be publishing more articles about mutual funds and investment strategies in the coming editions. Always consult your financial advisor before making investment decisions.
