Diversification is essential in mutual fund investments. A diversified mutual fund portfolio distributes the risk factor related to market investments. However, over-diversification too can be detrimental to your portfolio. As an investor, you will always ask how many mutual funds plans should I invest in to build my portfolio?
Types of mutual funds you can own
Based on your financial goals, you can invest in equity funds,debt funds, or hybrid funds.
Large-cap equity mutual funds
The term large-cap signifies the market size of companies mutual fund schemes invest in for returns. A large-cap mutual fund scheme invests in the top 100 companies listed on the stock exchange as per the market capitalisation.
Mid-cap equity mutual funds
Mid-cap mutual funds invest in companies ranking between 101 to 250 on the stock exchange by total market capitalisation. These companies possess high growth potential and exhibit lower risks as compared to small-cap companies, but higher risk when compared to large-cap companies.
Small-cap mutual funds
These mutual funds invest in small companies. They carry high risk as the small-cap companies can see sharp rise and fall in share prices due to any external factor.
Mutual funds that invest money in a particular industry are called sectoral funds. For example, technology funds that invest in tech companies. It is more like buying small pieces of shares of several technology companies. Hence, it requires comprehensive research before investing.
From an income generation perspective, you can invest in debt funds that in turn invest in fixed income securities such as government securities, bonds, debentures, and other money market instruments. They offer low risk.
Lastly, there is an option of hybrid funds. It is a mix of equity and fixed-income funds. You can invest in them from a growth and income generation perspective.
How to diversify?
- Invest in 2-3 large-cap funds to avoid overlapping of shares owned by your mutual fund schemes.
- Invest in not more than two mid-cap funds to offset the risk factor in favour of high returns.
- Invest a minor amount in two small-cap funds to mitigate the risks of high volatility.
- Invest in industries you have good knowledge about through sectoral funds.
- Invest in fixed-income funds to play safe.
- Invest in hybrid funds for 2-in-1 benefits.
Risks of over-diversification
Diversifying the portfolio often gets miscalculated. And beyond a point, diversification becomes counterproductive as even if one set of investments performs well, you won’t gain much. Therefore, it is best to diversify your investments in fewer funds of different types. Talking about equity mutual funds, they already invest in about 50 to 100 shares, thus diversifying your portfolio. You have to pick the right one for yourself.