When it comes to investing in mutual funds, many investors tend to inquire if it would help to invest in different schemes within the same category. They cite reasons like lower net asset value (NAV), different fund management, lower expense ratio, and their intent to benefit from momentum investing by some mutual fund houses. However, it again brings us back to an important question, “Will it enable diversification?”.
Diversification stands as a paramount tenet in the realm of investment. It entails the strategy of distributing your investments among a diverse range of asset categories, sectors, and enterprises, with the aim of mitigating your overall exposure to risk.
The stock market's inherent volatility implies that stock prices can undergo substantial fluctuations over time. Should you concentrate all your funds into a single stock or even a solitary sector within the stock market, you expose yourself to a substantial degree of risk. In the event that the chosen stock or sector fails to perform as anticipated, your potential losses could be substantial.
Diversification serves as a risk mitigation strategy by dispersing your investments across various avenues. When one stock or sector underperforms, the presence of other investments can potentially offset the losses. For instance, if your portfolio comprises a mixture of large-cap, small-cap, and international stocks, the likelihood of your entire portfolio depreciating in value due to one sector's underperformance diminishes. This has led several people to ask if they should invest in more than one mutual fund in the same category. Will it affect the intent to diversify or would it lead to duplication of returns when invested in the same or similar categories?
A discussion with some personal financial experts underlined their views for and against investing in mutual funds within the same category.
Hiren Thakkar, Chartered Accountant Proprietor, Hiren S Thakkar & Associates said, “Ideally No. Because it won’t serve the purpose. Find one fund and stick with one fund; the reason being there will be overlapping of stocks and why unnecessarily diversify with the same strategy?”
Mayur Shah, CFPCM & Founder, Imperial Financial Services shared, “Investors should avoid investing in multiple schemes of the same category to avoid the duplication of stocks in the portfolio. Also, it becomes very difficult to do qualitative and quantitative analysis of the schemes on a regular basis and to keep track of all imp updates of the schemes, if the number of schemes is more in the portfolio. Even if the investment amount is very big then we recommend a maximum of up to two schemes from the same category.”
Focus on portfolio diversification
Diversifying your equity portfolio can be achieved through several methods. One approach involves allocating your investments across various asset classes, including stocks, bonds, and cash. Another method involves spreading your investments across distinct sectors within the stock market, such as technology, healthcare, and financials. Additionally, diversification can be achieved by investing in companies of varying sizes, ranging from large-cap to small-cap enterprises.
Here are some specific guidelines for diversifying your equity portfolio:
- Consider investing in various mutual funds or ETFs. This provides an excellent means to gain exposure to a broad spectrum of stocks without the need to individually select stocks.
- Opt for a blend of large-cap, small-cap, and international stocks. Large-cap stocks typically offer greater stability, while small-cap and international stocks have the potential for higher returns, albeit with increased risk.
- Diversify across different sectors within the stock market. This approach helps you mitigate overexposure to any single sector.
- Regularly rebalance your portfolio. This involves selling some of your winning investments and acquiring more of your underperforming assets to sustain your desired asset allocation.
While diversification does not provide an absolute safeguard against losses, it remains among the most effective strategies for diminishing risk and enhancing your prospects for long-term success.