Mutual fund is a pool of money collected from many investors for further investing in various securities like bonds, shares, money market instruments, etc under the supervision of an expert.
And diversification means investing in a number of instruments to minimize risk.There are so many options in mutual funds that you may get wonder which would be the right category or right fund for you.
In this article
Can You Design a Perfect Mutual Fund Portfolio?
First of all, let me tell you one thing, there is nothing called ‘the perfect mutual fund portfolio’.
Every fund is designed according to different needs and a market scenario. So, if you are a mutual fund investor and want to achieve true diversification, then you will have to invest in schemes having different stock holdings/securities, benchmarks, market risk factor, mutual fund categories, etc.
One of the foremost things to look into before investing is to decide what your investment goal is.
Be very specific about your need and purpose of investment, and then you can decide what to invest in and how much to allocate in a particular investment.
Here are a few things that will help you make a well-diversified mutual fund portfolio
1.Understand the Allocation of Investments
Many investors think that once they have invested in a mutual fund, their work is done.
But that’s not the case.
While you can select the schemes of mutual funds while investing and can make a diversified portfolio, you still have to keep reviewing your portfolio on a timely basis to maintain the diversification of your portfolio.
You will have to strategically allocate the assets in your portfolio which will help you minimize the risk. Going by the principle of diversification, it means investing in a combination of assets rather than focusing on one.
So, try to keep a mixture of equity and debt funds in your portfolio by either investing in individual categories or hybrid category.
2.Know the various Stock Holdings
It is good to know the assets in which the mutual fund is investing to get the maximum benefit of diversification.
Moreover, you should evaluate certain parameters such as the fund’s investment style, the correlation between funds, stock overlap, etc, before choosing the funds for your portfolio.
The basic objective should be to define a specific role for each fund in your overall portfolio by selecting funds that are different from each other rather than similar ones.
Holding funds with different stock holdings or low stock overlap will help you to reduce the risk of your portfolio and will improve the risk-reward of your portfolio.
Think of it this way.
In your wardrobe, you need various types of clothes. Wollen clothes for the winter, breezy cotton outfits for the summer and raincoats for the monsoon. You need a mix of all types of clothing to get you through the year.
Similarly, you need to invest in funds of different categories, to reap maximum returns
3.Invest in Funds From Different Asset Management Companies (AMC’s)
Every AMC designs their own schemes that have certain investment objectives.
Selecting funds from different AMC’s can help you in reducing risk as the investment objective differs from company to company.
Thus, returns may vary even though most of the stock holding remains the same between two schemes of different AMCs.
Also, decision taken by different fund managers varies while managing their funds which in turn can reduce the overall risk in your portfolio.
4. Investment Horizon Must Vary
The investment horizon of two different schemes can also minimize the risk in your portfolio because the investment objective differs from scheme to scheme.
Most importantly, you should link your investment to a specific financial goal.
A combination of asset class level and fund level diversification will ultimately help in bringing down the overall risk of the portfolio.
Moreover, you should invest money for a different period in a particular scheme. This will help you fulfill your financial need at the right time without affecting your portfolio.
5. Analyze the Benchmark of the Scheme
Every mutual fund scheme has its own benchmark for say CNX 50, BSE mid-cap, BSE 100, etc. which means that the stock holding belongs to the companies which are listed either in NSE (National Stock Exchange) or BSE (Bombay Stock Exchange).
Accordingly, the risk of these schemes vary as per the benchmark of the scheme. Therefore, you should try and have schemes with different benchmarks in your portfolio.
Having schemes from different AMC but with the same benchmark may not give you true diversification, as the investment of both the funds might be the same just the proportion will differ.
Anything Else to Remember?
So, here were some ways through which you can make a well-diversified mutual fund portfolio.
Before choosing any fund for your portfolio, you should have the basic knowledge about the category of the fund, its objective, the AMC of the fund, etc.
Further, you can check on the performance of the fund, but just going by the past performance of the fund won’t help. You should try to plan your investment and choose the schemes which have consistent returns across all market cycles.
Thus, a well diversified portfolio of a mutual fund will help you increase your return potential and decrease risk while having the right asset mix.
Disclaimer: The views expressed in this post are that of the author and not those of Groww