Tips On Decluttering Your Mutual Fund Portfolio

Is managing your mutual fund portfolio proving to be difficult? If you answered yes, then you have an extremely messy portfolio that needs to be cleaned up. In this story, Henil Shah outlines what a cluttered portfolio is and what steps you may take to clear it .

In recent years, mutual funds have become more popular among retail investors. This is obvious from the Association of Mutual Funds in India’s (AMFI) Systematic Investment Plan (SIP) contribution statistics.

SIP investments have increased in recent months, as seen in the graph above, even as Nifty 50 approaches its all-time high of 18,600. Not only that, but the number of newly registered SIPs has climbed from 21.82 lakhs to 23.66 lakhs, representing an 8 per cent growth in the past six months.

However, due to a lack of fundamental understanding of mutual funds and incorrect financial advice, investors typically end up with a bloated mutual fund portfolio that includes underperforming funds, duplicate investments and a sub-optimal asset allocation. In this story, we have covered what clutter is in a mutual fund portfolio and how to streamline it.

Understanding the Clutter

How many mutual funds do you have in your portfolio? If you have been investing for a while, the probability is that you may have amassed a few mutual funds either by investing in a trending mutual fund, a new fund offer (NFO) or by acting on the advice dished out by your friends and family. The reasons might be several, but the fundamental one is to generate larger returns while taking on less risk. And, in order to reduce risk, you diversify your portfolio.

Many experts have spoken about the advantages of diversification and the arguments why you should invest in multiple funds to reduce risk. Nevertheless, the majority of these experts don’t really indicate a certain number of funds to invest in. As a result, it is critical to grasp how much is too much for you. A portfolio of several funds is customary for someone who has been actively investing for five years or more. Most of these decisions were made over time, taking into account market conditions or personal finance shifts.

However, having too many funds have a drawback. Having higher number of funds in your portfolio usually makes it quite challenging to manage. You may argue that having more funds means better diversification, but there’s a potential that a few funds will have holdings from the same universe, which won’t assist much with portfolio diversification. Understanding this via the use of an example can help you comprehend it much better.

Assume that you intend to diversify your mutual fund investments by investing in Large-Cap, Mid-Cap and Small-Cap funds. To further diversify your portfolio, you consider investing in sectoral funds such as banking and financial services, pharmaceuticals, information technology, and so on. Furthermore, you go on to include NFOs that you find compelling. Over time, you may end up with 20-30 funds in your portfolio. Although this appears to be a good mix, how frequently do you anticipate being able to monitor them? Furthermore, investing in this manner leads to portfolio overlap. There are numerous factors that contribute to a mutual fund portfolio being cluttered, even though we have only provided one example. Therefore, as a smart investor you should declutter and simplify your portfolio at least once a year.

Cleaning your Mutual Fund Portfolio

You may declutter your portfolio using a variety of methods. We have outlined in detail various measures that you may take to simplify your portfolio:

Periodically Revisiting Financial Goals — Financial goals are the amount of money needed to achieve various life goals, such as saving for a child’s further education, purchasing a home or car, or amassing a corpus for your post-retirement life. As a result, it is advisable to examine your financial goals to determine any modifications in the necessary corpus. Online SIP calculators can be used to determine the monthly contributions needed to attain the revised corpus for each of your financial goals.

Defining Asset Allocation Strategy — During the financial decision-making process, many investors are swayed by emotions or family members and friends. However, such investments may not be appropriate for their time horizon or risk tolerance. The first step in correcting bad decisions is to develop an asset allocation plan. Asset allocation is the act of balancing risk and return by spreading assets across several asset classes such as equities, debt, cash equivalents, gold, and so on, based on your risk tolerance, financial goals and investment horizon.

For example, because equities have the potential to beat inflation and other asset classes by a considerable margin over the long run, investments for financial goals that mature after five years must be allocated to equities. Similarly, because stocks can be volatile in the short term, risk-averse investors should use Debt Funds to accomplish financial goals maturing in three years. Debt funds offer stronger capital protection and income stability than equity funds. A well-planned asset allocation strategy will assist you in achieving the best risk-adjusted returns for your varied financial objectives.

Getting Rid of Underperforming Funds — Even if your present portfolio components are in line with your asset allocation plan and financial objectives, you may notice that a handful of them are consistently failing against their peers and benchmark. That is because mutual fund schemes that performed well in the past cannot guarantee future performance. Moreover, there are funds that might consistently underperform for an extended period of time. Hence, it is critical that you discover and redeem such funds from your portfolio. Quarterly, compare the performance of your existing funds against their benchmark indices and peers. Redeem funds that have regularly outperformed their peers and benchmark over the last 10 rolling quarters.

Restructuring the Portfolio — Restructure your portfolio in accordance with your financial goals after you have recognised them and developed the necessary asset allocation plan. Recognise funds that are a good fit for your objectives and asset allocation plan. Compare the performance of selected funds to the performance of peer funds and benchmark over a shorter and longer time period. This would be useful in determining if such funds have consistently exceeded their benchmark and peers in all market scenarios.

Keep in mind that while previous outperformance may not be repeated in the future, fund comparisons can give you a sense of how well a scheme might do in different market situations. Avoid over-diversification when reorganising your mutual fund portfolio, as this might make tracking difficult. Over-diversification might reduce your overall returns from a mutual fund portfolio. Diversifying within the same fund category makes little sense because their constituent units are likely to follow the same path.

Reviewing your Portfolio — Once you have decluttered your mutual fund portfolio, go over it at least once a year. This would allow you to adjust your mutual fund portfolio in response to changes in your risk tolerance, financial goals, various macroeconomic indicators and the fund’s fundamental characteristics. Periodic review can also help identify underperforming funds and address variances caused by the prior portfolio asset mix.

Conclusion

In the absence of competent guidance, it is rather clear to have an unmanageable number of funds. This might be because people are fundamentally uninformed of how to invest in mutual funds. This frequently results in a number of unnecessary funds in your portfolio that bring little value in terms of returns or diversification. As a result, if your portfolio contains more than 10-15 funds (depending on your investment amount), it is time to clean it up and get rid of all the unnecessary complexity.