Most investors believe that buying more mutual funds will reduce their investment risk. At first glance, this seems like a good idea. After all, more funds should mean more variety, right? But that’s not always true. Holding too many mutual funds can do more harm than good to your overall returns and peace of mind.
Let’s understand this with an easy-to-follow approach. In mutual fund investing, “diversification” means spreading your money across different types of investments. This is done to reduce the impact of a single bad-performing investment on your total portfolio. But there is a limit to how much diversification is good. Beyond a point, adding more funds only increases confusion and lowers performance.
What Is Diversification in Mutual Fund Investing?
Diversification means investing across different asset classes, sectors, and geographies. Its main goal is to reduce risk and bring stable long-term returns. For example, an investor can diversify by putting money into:
- Equity (stocks)
- Debt (bonds or fixed-income)
- Gold (via ETFs or funds)
- Real estate (through REITs)
- Cash or liquid assets
So, if one asset class performs poorly, the others might perform better and balance out the loss.
But mutual funds themselves already offer in-built diversification. Most equity mutual funds invest in 30–50 different stocks. Debt funds invest in a mix of corporate and government bonds. Hybrid funds combine both equity and debt. This means even a single mutual fund is not focused on just one company or asset.
Are More Mutual Funds Equal to Better Diversification?
No. Buying more mutual funds doesn’t always mean your investments are safer. Many times, investors end up buying funds that invest in the same set of stocks or sectors. This leads to portfolio overlap, where multiple funds hold similar assets. For example:
If you buy five different large-cap equity funds, chances are all of them have invested in the same big companies like Reliance, TCS, HDFC Bank, etc. So even though you hold five funds, your money is exposed to the same risks.
This is not true diversification. You are just multiplying the number of funds without changing the core of your portfolio.
Real Diversification Comes From Mixing Asset Classes
To build a better mutual fund portfolio, focus on including different types of funds, not just more funds.
Here’s an example of a smartly diversified 3-fund portfolio:
- Flexi Cap Equity Fund – Gives you exposure to large, mid, and small-cap stocks.
- Short-Term Debt Fund – Adds safety and steady returns through fixed-income instruments.
- Gold ETF or Fund – Gives protection during stock market volatility and acts as a hedge.
With just three funds, this portfolio gives you exposure to equity, debt, and gold – a much better diversification than holding eight equity funds.
The Problem With Owning Too Many Funds
Let’s say you hold 8–10 mutual funds. You may think your money is safer, but here are the problems you may face:
1. Difficult to Track Performance
Monitoring 10 funds regularly is not easy. You’ll find it hard to track which ones are doing well and which ones are not.
2. Diminished Returns
When too many funds are in the portfolio, even a top-performing fund won’t impact your overall returns much. Good gains get diluted.
3. Portfolio Overlap
You might unknowingly invest in multiple funds holding the same stocks. This doesn’t improve diversification but only adds complexity.
4. Higher Costs
Each fund has an expense ratio. More funds mean higher overall cost, especially if you choose actively managed funds.
How Many Mutual Funds Are Ideal?
There’s no fixed number, but for most small or retail investors, 3 to 5 well-chosen mutual funds are more than enough. What matters is quality over quantity.
For example:
- One diversified equity fund (Flexi Cap or Multi Cap)
- One debt fund (Short Duration or Corporate Bond Fund)
- One gold fund or ETF
If your investment amount is large, you can add one or two more based on your financial goals like:
- One international equity fund for geographic diversification
- One sectoral or thematic fund for focused exposure (only if you understand the sector)
Tips to Diversify a Mutual Fund Portfolio Properly
Here are some useful points for smart mutual fund diversification:
- Mix Asset Classes – Include equity, debt, and gold.
- Check Sector Exposure – Avoid funds with similar sector allocation.
- Avoid Multiple Funds of Same Category – No need for three large-cap equity funds.
- Understand Fund Strategy – Know where and how your money is invested.
- Look at Fund Overlap Tools – Many platforms offer tools to check overlapping stocks in your funds.
- Review Periodically – Track your portfolio every 6 months and make changes only when required.
What Happens If You Don’t Diversify Correctly?
If you don’t diversify properly, you increase your risk unnecessarily. For example:
- If your entire investment is in equity, you face high risk during a market crash.
- If all your funds are in the same sector (like IT or pharma), your portfolio will suffer if that sector underperforms.
- If all funds are active funds with high expense ratios, your cost will eat into your profits.
That’s why proper diversification isn’t just about reducing risk – it’s also about optimising returns and managing investment cost.
Final Portfolio Setup for Small Investors
Here’s a basic recommended mutual fund portfolio setup for a retail investor:
| Fund Type | Purpose |
| Flexi Cap Equity Fund | Growth from equity market |
| Short Duration Debt Fund | Stability and fixed income |
| Gold ETF or Fund | Hedge and inflation protection |
| International Equity Fund (Optional) | Global exposure |
This setup gives you a balance of growth, safety, and diversification.
Disclaimer: Mutual fund investments are subject to market risks. Please read the scheme-related documents carefully before investing. It is advised to consult a certified financial advisor for personalized investment planning.
Source: Financial Express
