When it comes to investing in schemes, the first thing that comes to mind is - how do we reduce our risk? Diversification might be one of the best ways to mitigate risk but investing in a large number of scheme in the name of diversification is not the best investment decision.
So, it all comes down to the question, "How many mutual funds should one own?" The answer lies in your investment goals. In fact, The Economic Times stated that one should invest in at least 3-4 funds to be fully diversified, ensuring that the funds cover the entire gamut of multi-cap, debt and tax saving schemes. These should be sufficient to ensure a diversified portfolio. However, there is no one-size-fits-all strategy. It all depends on the capital you have for investment, your financial goals, the timeframe of investment and your risk appetite. As excess of anything is bad for us, so is diversification. Here's why.
Portfolio Duplication
Diversification is attainable by investing in multiple schemes. But while investing, make sure that the schemes are not of the same category. This could harm your portfolio, since same category schemes tend to invest in similar types of assets, thus leading to duplication of your portfolio.
Over Spreading
Diversifying your portfolio to different sectors could reduce your risk. However, just as spreading cheese too thin on a slice of bread would make it tasteless, so would spreading your investment too widely impact your financial goals adversely. The slack of some assets might hamper the performers of your portfolio. In some instances, the gains might not even cover the losses that you would incur.
Scheme Management
If you have spare time at hand and are truly devoted to the investment, then alone you should opt for diversification. Without well-informed investment decisions, over-diversification could occur, leading to problems in managing your portfolio. For instance, if you wish to invest in equity and your portfolio consists of about 50 stocks, it would only lead to confusion as to which to sell and which to hold.
If you really want to invest in more than three different mutual funds, make sure that they are diversified by sectors or schemes. The more schemes you have with a variety of assets, the more likely you are to mitigate risks. But, remember, over-diversification could backfire and harm your returns in the worst way. So, study each scheme carefully and seek assistance of the fund provider to make a well-informed investment decision.