In today’s fast-paced investment world, many mutual fund investors find themselves juggling numerous schemes, often with portfolios containing 30 to 40 different funds. While the reasons for accumulating so many investments may vary—from chasing past returns to taking advantage of tax savings—this approach can lead to an overcomplicated and inefficient portfolio. In this blog, we’ll explore why having too many funds can dilute your returns, make portfolio management more challenging, and result in index-like performance despite higher costs. We’ll also provide strategies to help you streamline your mutual fund portfolio for better outcomes.
Fund collectors are familiar among fund investors. Many fund investors have a large number of schemes, sometimes up to 40 or even 50. This is due to various reasons:
- Chasing Past Returns: Investors may buy multiple schemes without assessing their actual needs.
- Tax Savings: Some individuals purchase a new ELSS (Equity Linked Savings Scheme) every year, leading to an excess of these funds due to the three-year lock-in period.
- Investment Themes: Others become captivated by investment themes and new funds, resulting in an overload of investments.
The result is often the same: Too much money tied up in various schemes.
You may be wondering what the problem is. Even if you are an expert investor, having too many funds is not advisable. More on this later. Another question related to this issue is the ideal number of funds one should have—the answer is four to five. You may think this is a low number, but a mutual fund typically contains between 40 and 80 securities (stocks and bonds). A well-diversified fund can provide sufficient exposure. Four to five funds from various fund houses are adequate to ensure diversification.
Why Not Invest in Many Mutual Funds?
Unintended consequences of having too many investments in your portfolio include the following:
1. Diluted Returns
You will find that only a few of your 30-40 schemes have significant allocations. Even if some funds provide excellent returns, they won’t necessarily translate to superior returns for your overall portfolio.
Compare two portfolios, each worth Rs. 10 lakh. The first portfolio has five funds, and the second has twenty. Assume the money is equally divided among all the schemes. If one scheme delivers a higher return than the others, say 22% annually in both portfolios, and the remaining schemes yield only a 12% annualised return in the portfolio with five funds, the total corpus in the portfolio with five funds will be more significant.
2. Portfolio Becomes Index-Like
Investing in numerous funds can lead to holding many stocks, reducing the value of active investment and making your returns more index-like. Your expenses (expense ratio) will not be index-like, as most of your funds are actively managed. If you aim for returns similar to index funds, investing directly in index funds with low expense ratios would be the best approach.
3. Difficulty in Managing Your Portfolio
Having too many mutual funds makes it difficult to track performance and exit individual funds when they aren’t performing well. Managing taxes and filing returns can also become complicated with a large number of funds.
How to Reduce the Number of Funds in Your Portfolio?
Now that you know that excessive funds can harm your portfolio, let’s examine some strategies to eliminate excess funds.
1. Exit the Underperformers
Cut down on the underperformers. If a fund has underperformed compared to its peers or benchmarks for at least two years, it’s likely not worth your money. Investors often worry about the taxes they might incur if they sell underperforming funds. However, the opportunity cost of investing in an underperforming fund can outweigh any tax savings.
For example, if you invested Rs. 10 lakh and the fund’s annualised return was just 8% over the last three years, it’s likely to continue delivering similar returns in the future.
2. Exit Sectoral Funds and Thematic Funds
Investors often choose sectoral or thematic funds based on short-term performance. However, these funds are generally not suitable for the average investor due to limited diversification and potential volatility. A plain vanilla fund can provide the necessary exposure without the added risks.
3. Assess the Need for Small/Mid-Cap Funds
Mid- and small-cap funds are riskier and more volatile than flexi-cap funds. They should only comprise a maximum of 30% of your portfolio for those willing to take on extra risk for potentially higher returns. If you do not want to assume extra risk, consider removing mid/small-cap funds from your portfolio.
4. Ask Yourself Why You Invested in Large-Cap Funds
Large-cap funds cater to conservative investors seeking modest portfolio growth without much risk. Flexi-cap funds are a better option for most investors looking to build wealth through equity funds, as they can invest in all companies regardless of size. If you lack a compelling reason for holding large-cap funds, consider exiting them.
5. Evaluate Your Exposure to Debt
Many investors in India favour debt instruments. It’s essential to assess the debt funds in your portfolio. Debt funds are necessary for the fixed-income component of your overall portfolio. Your asset allocation should guide how much fixed income you need. Consider reducing your debt exposure, including small-savings schemes such as PPFs, Sukanya Samriddhi Yojanas, and National Savings Certificates. Don’t forget to account for bank fixed deposits and recurring deposits.
6. Consider Hybrid Funds
Hybrid funds are a good option for beginners, as they invest in both debt and equity, automatically allocating assets. Balanced advantage funds are suitable for novice investors, allowing fund managers to adjust asset allocation dynamically to optimise returns and manage risk.
If you purchased hybrid funds for a specific reason, keep them in your portfolio. However, if you bought them without much thought, reconsider their inclusion.
7. Check for Portfolio Overlap
Portfolio overlap occurs when your schemes hold a high percentage of similar securities. While you may own separate funds at the security level (stocks and bonds), they may still represent duplicates. Removing these duplicates can simplify your portfolio.
8. Realign Your Portfolio with Your Goals
Your portfolio should align with your financial goals, which can be short-term, medium-term, or long-term. Create a model portfolio based on your goals, desired asset allocation, and other factors. Compare your current portfolio with this model and remove any funds that don’t support your objectives.
9. Use a Portfolio Health Check Tool
Consider using a portfolio health check tool to check mutual fund portfolio overlap. These tools can help identify issues within your portfolio, enabling you to exit unwanted funds.
Conclusion
Simplicity is key to successful mutual fund investment. Reflect on why you invested in mutual funds in the first place. You likely sought good returns without direct exposure to stocks and bonds. You wanted to combine simplicity with a reasonable return on investment. However, you may unintentionally work against your goal by investing in too many different funds. Take the time to reassess your portfolio.
