Mutual fund advisors say investors should always keep in mind the basic objective of diversification. They point out that the basic idea behind diversification is to invest across asset classes to reduce the overall risk without compromising on the returns. However, when you are spreading your investments across many mutual fund categories and schemes without giving it a proper thought, it often doesn’t result in optimisation of resources or maximising wealth.
Many mutual fund houses have been advocating goal-based investing in mutual funds for a while now. The rationale behind the initiative was to help investors to allocate money in the right asset classes to achieve various goals. For example, if you follow goal-based investing, you would automatically choose debt schemes to take care of your short-term goals and equity schemes to meet your long-term goals.
Too many categories and schemes
One of the common features in many problematic portfolios is the presence of several mutual fund categories and schemes. Many investors mistakenly believe that investing across different mutual fund categories, especially equity mutual fund categories, would help them to achieve diversification. The trouble is that the diversification is not done with their goals and risk profile in mind. For example, a conservative investor need not invest in small cap schemes to achieve diversification. Also, too many schemes in the same mutual fund category often results in overlapping of the portfolio.
Here is an example
A conservative investor can invest mostly in large cap mutual funds to achieve her long-term goals. If she wants to reduce the risk in the portfolio, she can invest a small part of her investments in aggressive hybrid schemes or balanced schemes. She also has the option of adding debt mutual fund schemes to her portfolio. Similarly, an aggressive investor may add a multi cap mutual fund scheme to portfolio with her mid cap investments.