Diversification is a vital part of investing, and also a practice which is key to helping one extract the maximum benefit from their investments. In layman terms, diversification refers to choosing a balanced assortment of investments across different risk categories – low, medium, and high. The purpose of diversification is quite simple – to mitigate risks, and help the investor gain optimally from their chosen bouquet of investments. However, contrary to the widely-help opinion, diversification is not limited to making investments in a variety of securities.
Speaking of mutual funds (MF), a diversified MF portfolio may be relatively easier due to two reasons. First, mutual funds allow the liberty of instant diversification. A fixed amount of capital may be invested in a variety of funds, thus creating a diverse MF portfolio. Second, mutual fund investments allow one to diversify across different sectors, styles, countries, and securities. However, there are certain details one must be aware of when attempting to achieve a diversified yet balanced mutual fund portfolio. Read on to know more about them.
Diverse doesn’t essentially mean different
Align investment allocation with your financial goals
Review stockholding before investing
Invest with multiple Asset Management Companies (AMCs)
Choose varied indices
Many first-time mutual fund investors may confuse diversification with investing in different mutual funds. This may altogether defeat the purpose of diversification itself as capital may be invested in mutual funds that are different but with similar holdings. In this case, the same risk will affect the securities held in both funds. If your aim is to bring about portfolio diversification, you must invest in mutual funds which do not have similar holdings. Instead, invest in funds across multiple categories and sectors, which will provide exposure to an assortment of funds.
While investing in mutual funds, ensure that you exercise caution when investing in multiple asset classes. What does this mean? It means that you must invest not only in equity, but also debt funds to ensure that your returns are shielded from risk. For added tax benefits, you may also explore to balanced funds or hybrid funds as an investment option. It goes without saying, that the one thing you must give utmost priority to when investing must be your investment goal, because that is the very reason for which you are investing in the first place.
To ensure that the investment offers the maximum capital benefit, mutual fund investors must pay close attention to the stockholdings of all their funds. As mentioned above, overlapping stockholdings i.e. when two or more funds have similar stockholdings, they will be affected by similar risks, which can, in turn, affect their returns. It is imperative that investors choose funds carefully so as to ensure minimum stockholding overlap which would help reduce risk, and maximise returns.
When it comes to mutual funds, different AMCs put together schemes with varying investment objectives. The stockholdings and themes of these schemes designed by different AMCs may be similar in some aspects, but their investment objectives and strategies will be dissimilar. This is what will help mitigate risk and secure one’s portfolio returns against adverse periods of market performance.
Anyone who is familiar with mutual funds will also know that funds typically track one or more indices. Each index comprises a bunch of companies which have been chosen based on a specific theme. The stocks listed under the funds of a portfolio belong to the companies included in the index. For example, a mutual fund which tracks the Nifty 50 index will comprise stocks from companies that are part of the said index, such as Asian Paint, Bajaj Finance, Axis Bank, and other leading ones. Therefore, before choosing a mutual fund to include in their portfolio, investors must understand the risk that accompanies the index which their chosen fund tracks. It is, however, advisable that one invest in mutual funds which track multiple and varied indices so as to distribute and reduce risk.
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