Guide on Minimizing Investment Holdings in Your Financial Portfolio
In the world of investments, diversification is key to managing risk and maximizing returns. However, when it comes to mutual funds, striking the right balance is crucial. According to financial experts, a portfolio consisting of 3 to 4 mutual funds is generally considered ideal for optimal diversification and returns.
Each mutual fund, by its very nature, is an inherently diversified investment vehicle. This means that adding too many funds may lead to diminishing returns and unnecessary complexity without additional diversification benefits.
The right combination of mutual funds depends on your investment goals, time horizon, and risk appetite. For instance, equity funds are ideal for long-term growth, while debt or hybrid funds are more suitable for moderate risk or shorter horizons.
Regular portfolio rebalancing, such as annually, ensures your chosen funds remain aligned with your diversification and risk goals.
Mid/small-cap funds, while they may offer a better return profile than flexi-cap funds, come with higher volatility. This is demonstrated by the standard deviation of five-year rolling returns. Therefore, they should only be invested in by those willing to take extra risk for extra returns, not exceeding 30% of the portfolio.
On the other hand, sectoral and thematic funds, while appealing due to short-term performance, provide limited diversification and can be very volatile. They can also lead to a high concentration in specific sectors, increasing risk. Moreover, investing in more than 40-50 mutual funds can dilute returns, as few schemes may have significant allocation.
Investing in fewer funds can help avoid the negative effects of excessive diversification, such as dilution of returns and difficulty in managing the portfolio. It can also make it easier to track individual fund performance and exit underperforming funds.
Portfolio overlap can occur when schemes in the portfolio have a large percentage of overlapping holdings. Exiting the duplicates can simplify the portfolio and help avoid unnecessary risk.
It's also important to exit underperforming funds, as this can lead to higher portfolio returns, even after considering taxes. A platform offers a free portfolio health check tool to identify issues with the portfolio and help exit undesirable funds.
Lastly, it's essential to ensure that your portfolio aligns with your financial goals. This involves analyzing your goals and desired asset allocation, removing funds that won't help with the goals, and building a model portfolio.
In conclusion, a well-chosen portfolio of 3 to 4 mutual funds typically suffices to build a diversified portfolio that balances risk and return effectively, allowing access to broad market exposure without overcomplicating the investment.
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