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MF Investment: Should you invest in multiple mutual funds?

MUTUAL FUND INVESTMENT: Many investors have struggled with bloated, excessively large portfolios and encountered difficulties in effectively monitoring them. The more diverse your holdings, the more difficult it will be to keep track of everything and keep an eye on your portfolio’s performance. Investors also become mired in their prejudices. Some investors, although having the means and excess to make larger investments, are unwilling to put in more in any given scheme even though it is performing well. Even if their income increases over time, they still don’t want to invest more than a specific (and equal) amount in each MF scheme. Over time, this causes an excess of variety.

In this way, investors frequently wind up with a portfolio that contains 15–20 or even more mutual funds. The fact of the matter is that an excessive amount of diversification is detrimental to the process of wealth creation. It’s been said that “too much of anything is good for nothing,” and that proverb certainly rings true when it comes to investment. When you reach a certain threshold, any new scheme you add to your mutual fund portfolio will:

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  • Do little more than take up space in your investment portfolio.
  • Add nothing of value
  • Not assist in reducing risk
  • Make the task of monitoring more difficult.
  • Prevent optimal resource use

If you invest a modest sum in a large number of different mutual fund schemes, you will not likely receive the benefits of diversification nor will you be able to maximise your gains. This is especially important to keep in mind when you are only investing a small sum. Investments in mutual funds should be done in accordance with the objectives, time horizon, and risk tolerance.

For instance, a cautious investor who wants to amass wealth over a protracted period of time without exposing themselves to an excessive amount of risk and volatility might put their money into large cap mutual funds. Flexi cap funds are a good option for investors who are willing to take on a moderate amount of risk. The portfolio can be adequately diversified with as little as four to six different schemes. One won’t get the highest return or most diversified portfolio by buying funds across all mutual fund categories. If you’re only investing a modest sum, it’s crucial that your portfolio reflects your objectives, time horizon, and risk tolerance.

For financial goals with a time horizon of up to three years, a debt fund is a good option. Although a limited fraction can be allocated to equity funds, the majority should go to debt funds. One should invest in equity mutual funds if the time horizon for the financial goal is longer than three years. The equity mutual funds should contain mutual funds from a variety of different categories, such as large cap, mid cap, and small cap mutual funds.

If you are a cautious investor who does not like watching their portfolio fluctuate daily, you should put your money into balanced funds that have a mix of debt and equity. Selecting an equity mutual fund for medium to long term financial goals should be done with a healthy dose of risk tolerance in mind.

To maximise wealth growth, it is crucial to know exactly how many schemes you should have in your portfolio. For this reason, it is counterproductive to add more mutual fund schemes to an already well-diversified portfolio in order to protect against losses due to a single stock or industry. Remember, one or two successful schemes can boost your portfolio’s overall performance, and with compact portfolio there is less paperwork involved.

If you find yourself with too many schemes and wish to pare them down, the following are some suggestions for making the necessary adjustments to your portfolio:

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Get rid of any schemes that have overlapping portfolios

It is possible that if you own several different schemes in the same category, they all invested in the same companies and employed similar trading techniques. In that situation, it won’t significantly improve the portfolio’s worth. For instance, if you invest in multiple large-cap funds, you may not see any outperformance from the group as a whole and instead get returns that are on par with the market. This negates the objective of putting money into actively managed schemes, which often have higher expenditure ratios in order to produce alpha.

To get the best possible diversification, set your investments in line with your objectives, level of risk tolerance, and time horizon for making investments. Equity funds are best for long-term objectives, debt funds for short-term objectives, and so on. If you don’t have a very high risk tolerance, reduce the amount of your portfolio that is allocated to riskier categories like mid-cap funds and small-cap funds (or credit risk funds in the case of debt investments). By doing so, you’ll be able to track how well the schemes are working toward your objectives.

It’s time to get rid of the chronic slackers

Observe how the investments in your portfolio are performing. Schemes that frequently underperform relative to their benchmark and the category average should be discontinued. Don’t base your judgment, though, only on short-term underachievers. The fund should be able to take advantage of up markets and actively engage during recoveries, while also providing adequate protection against losses during market downturns.

Consider the scheme’s Sharpe Ratio, Sortino Ratio, Standard Deviation, and other risk-reward metrics to determine if it has shown consistent performance across market cycles. Consider the scheme’s portfolio characteristics, the fund house’s efficiency, and the competence of the fund management team as important quantitative elements in influencing the scheme’s performance consistency.

When planning to depart the scheme, take into account the expenses and tax repercussions. If you cash out (or switch funds) within a year of making your initial investment, you’ll likely have to pay an exit load. Second, any profit you make when selling an investment may be subject to capital gains tax.

For equities funds, the long-term capital gain tax rate is 10% if redeemed after one year (only on gains over Rs 1 lakh in a financial year) and 15% if held for less than a year.

Investments made in debt funds for a period of time greater than three years are regarded as long-term investments, and gains are taxed at a rate of 20% (excluding of surcharge and cess) with the advantage of indexation. Gains are taxed according to the investor’s income tax bracket rate when investments are made for less than three years.

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