Do you know how to diversify your Mutual Fund Portfolio?

Diversification plays a major role in investment. It's all about adding variety to your investment portfolio or investing in diversified investment tools to bring down investment risks. You can allocate your money into different types of investments such as Gold, Stocks, Mutual Funds, Bonds, Insurance, Real Estate and other assets classes and expect to get a balanced return in the future. For example, if you are investing all your savings in gold, and gold price drops for a continued, your investments will suffer loss. But, if you have put some amount of your savings in Mutual Fund along with investing in gold, you could have minimized the overall risk. Hence, allocating your savings in diversified investment tools helps providing you a safety net.

What is a diversified Mutual Fund portfolio?

There are two ways diversification works when it comes to mutual fund investment - instant diversification and portfolio diversification. Well, how instant diversification works? When you invest in a particular mutual fund scheme, you buy units of that fund which invest across a variety of securities. Here, investing in one scheme, you get the benefits of instant diversification. But, if you really want to optimize your returns on mutual fund investments, you should opt for a portfolio diversification wherein you purchase different funds/ schemes that invest in different asset classes/securities which are not correlated to each other.

How to diversify your Mutual Fund Portfolio?

To create a diversified mutual fund portfolio in the real sense, you need to choose your funds carefully and invest in different types of funds that have holdings in diverse stocks/ securities:

1. For example, you may have invested in two different mutual funds provided by two different mutual fund companies. But, if both the funds have the same holdings or they invest in the same securities, it does not really help you minimize the risk factor. Therefore, in your investment portfolio, you should carefully choose funds/schemes that invest in different securities like stocks, bonds, gold, precious metals and other asset classes. It always important to spread your money across different securities, because any failure or drop in one particular security will not affect your entire portfolio and overall returns.
2. You can choose to invest in different types of mutual funds such as equity funds, debt funds or hybrid funds based on your future requirements. For example, if your requirement is to get higher capital gains to meet your long term financial goals, which is at least 5 to 10 years away from now, you can choose to include equity funds in your portfolio. Similarly, if you don't want to take a risk and yet receive predictable income to meet your short term goals, you can opt for debt funds. Also, you can choose to include both equity and debt funds in your portfolio, if future financial requirements demand both.

1. It's important to choose mutual fund schemes from different Asset Management Companies (AMC). Each AMC designs their schemes keeping certain investment objectives in mind, although the funds may invest in the same asset classes where other mutual fund companies have already invested. Mostly, the investment objectives of one AMC differs from another, and this helps in minimizing your investment risks and optimizing your returns.
2. Also, try to include funds that have different benchmarks. The benchmark of a fund is decided by a fund house as per the investment objective of a fund. It is a standard against which performance of a mutual fund is measured. When you compare a scheme with its benchmark (e.g. CNX 50, , BSE 100, BSE mid-cap, CNX Midcap, CNX Small cap), it's important to consider the performance of the fund over a long period of time, say for a period of 5 to 10 years. If a fund has consistently delivered higher returns than its benchmark index, it shows consistency in fund performance. You can choose to include such funds in your portfolio.

Thus, a combination of different asset classes or securities offered by a particular mutual Fund scheme and investment in multiple mutual fund categories and/or schemes offered by different fund houses can definitely cut down the overall risk in your investment portfolio.

All said, you need not invest in a wide range of funds to create a diversified mutual fund portfolio. A diversified portfolio is not about how many funds you have invested in, it's about investing wisely across a variety of sectors and assets classes based on your future financial goals. Don't forget your specific long term or short term future goals when you choose a fund. For a better future planning, each mutual fund investment should be linked to your future financial goals.