Mutual Fund Diversification: To Do or Not To Do?

Many a time people ask me why would you only recommend 3 to 4 funds when there are so many on the offer! Questions like are you mad? Why can’t I add further 4 to 5 funds after all I am trying to do is to diversify/ spread my risk? Well, diversification to say is good to have but diversification beyond a point is actually bad for your portfolio.

Let me narrate you a short incident that you will be able to relate well. Recently, I had been to my friends’ marriage ceremony. They are a business class people so the occasion was bound to be a grand one. When I approached the eating counter with one of my friend we were amazed to find around 50 plus different vegetarian menus on the block and a further 20 such delicacies in the non vegetarian section. I can’t even remember their names well and most of the dishes were quite alien to me since I had never tasted most of them. This triggered a sense of exploration for my friend. He got ecstatic and wanted to taste most of the dishes on the offer - so in the end he had around 10 to 15 such dishes on his plate. He tried hard to enjoy them all. But, all that my friend could do was he wasted most of the food items as all of them got so mixed up that he could not relish any of the dishes well.

Reason is simple -  he over-diversified his plate and therefore could not enjoy the food well. This is what most investors do. They try to buy most of the funds in order to get the most out of it. But hang on are you really doing it right. It is actually a matter of diversification. Adding multiple funds in the idea of diversification can actually dilute your performance and overall returns. Keeping things simple is really important – your tax calculation, your interest rate calculations etc. Plus having more funds like 8 to 10 in your kitty will be quite an uphill task for you to track and manage your portfolio performance well.

Would you be really interested to repeat such mistakes in your portfolio? In the end all we want is returns and an easy to manage portfolio just like a plate of few delightful foods that we can savor and enjoy to the maximum.

I have always been choosy so I just picked those dishes which could satiate my hunger buds and gleefully enjoyed the dishes to the most. The investor needs to understand that in order to derive the maximum returns from your portfolio all you need is simplicity. So the next time when you hear the story of a new fund launch or a fund that has recently started SIPs etc. Think about it for a second are you really buying it for the sake of spreading your risk or is it otherwise. So don’t go overboard in the name of diversification. Till then Happy Investing.