All of us have heard diversification helps to reduce risk. But can same logic be applied to Mutual Funds, by owning a lot of mutual funds can you truly reduce risk?
Diversification is a risk management strategy with the goal is to reduce the portfolio’s exposure to any one specific security or market sector, so that the impact of any negative performance in one area is balanced by positive performance in others. But when it comes to Mutual Funds owing too many funds owning too many funds that have a similar investment strategy and hold similar stocks can lead to over-diversification and negatively impact returns.
So it’s important to understand the fund investment strategy and consider the overlap between different funds and choose a mix that provides diversification across different industries and sectors. Owing 5 small cap funds just for the sake of diversification does not reduce any risk.
The goal of diversification in Mutual Funds should be diversify across different asset classes, sector, market capitalization,
quality, etc.
For Example, it does not make sense to own two blue-chip funds since the overlap between them would be high. In such cases an investor can diversify by owning one large-cap fund and one mid-cap fund or sectoral fund. Please refer to our article https://myinvestbuddy.com/25-types-of-mutual-funds/ to understand various types of mutual funds available and choose one which suits your investment strategy.
Ultimately, the number of mutual funds that makes sense for an investor will depend on their financial goals, investment time horizon, and risk tolerance. A financial advisor can help determine the right mix of investments for an individual’s portfolio. You can also schedule a call with us here Consult Us, we will help you create an investment plan best suited for your goals and investment objectives.