How many mutual funds you should hold?

Mutual funds remain one of the best means to achieve your financial ends. You invest in various funds that help you attain your financial needs. However, many of us do not follow an organised approach while investing in mutual funds and end up holding funds that neither give you the needed diversification nor extra returns.

Most of us buy funds or do SIP just because it has given good returns in past and we want to ride the wave. Add to this, many of us also subscribe to new fund offers (NFOs) just because it is being offered at NAV of Rs. 10. This haphazard approach while selecting and investing in mutual fund hampers the long-term performance of your investment.

Therefore, the moot question is how many funds you should hold at a time? There is no thumb rule that explains this answer and it depends upon your financial goal, time horizon and risk-taking ability. If you are just looking for a diversification, a single fund can also provide you with the required diversification while in some cases even investment in five funds cannot give you the desired diversification as all funds might be focused in a single sector or market cap.

Therefore, the first step in determining the number of funds you need is to understand what is the purpose of your investment and what is your investment time horizon. Is it purely for diversification or for getting your asset allocation, right?

Diversification

If you are investing in a mutual fund for diversification, then 2-3 equity funds will give you the right diversification. As each fund contain anywhere between 30-70 stocks and even with overlapping of 50% of stocks, you will end up holding on average of 75 stocks. This number is more than enough to give you required diversification. Moreover, holding funds beyond this is going to make your holdings thin and is likely to impact your portfolio’s outperformance.

 Asset Allocation

Investment in a mutual fund is also used for right asset allocation. According to a study done by Mirae Asset MF, asset allocation strategies determine about 90% of investment results. Thumb rule of asset allocation is you should minus 100 from your age and invest the resultant percentage in risky assets such as equity funds and rest in less risky assets such as gilt funds or fixed deposits.

 For example, if your age is 30 years you can invest 70% (100 – 30) in equity funds and rest in debt funds, fixed deposits etc. Therefore, you can invest in 2-3 equity funds and a similar number in debt funds. The actual funds and numbers will finally depend upon your investment goal and time horizon.