Mastering Diversification: How Many Mutual Funds Do You Really Need?

In a conversation with Zee Business, mutual fund expert Vishwajeet Parashar and Rushabh Desai, Founder of Rupee with Rushabh Investment Services, emphasized that diversification in a portfolio is crucial for reaping profits during all market phases, whether it's an equity rally or a surge in gold prices. Diversification also helps cushion against market volatility.

Financial experts highlighted that nearly 91 per cent of portfolio success depends on asset allocation. For Indian investors aiming to create wealth in the long run, diversification and asset allocation strategies are more effective than trying to time the market, as no particular asset consistently outperforms over time.

Over the past 40–50 years, no asset class has delivered consistent outperformance. Sometimes equities lead, sometimes debt performs better, and at times gold delivers strong returns. This is why diversification is critical. According to Parashar, almost 91 per cent of the success of a portfolio depends on asset allocation, emphasizing the need to spread investments across different types of assets, such as equities, debts, gold, and real estate. Periodic rebalancing helps investors manage risks effectively while pursuing their objectives.

While a diversified portfolio may not always appear to be the best performer in the short term, it delivers more stable and consistent returns over time. The aim is to achieve risk-adjusted returns, allowing investors to stay invested without panic during market downturns. The longer you stay invested, the more compounding works in your favour.

Desai recommended that investors simplify their portfolio to suit their financial objectives, risk profile, and investment horizon. He identified three main types of investors:

1) Conservative investors : They should allocate 70–80 per cent to debt and 20–30 per cent to equities, focusing on the security of capital along with relatively lower returns and a minimum horizon of three years. 2) Moderate investors : They can allocate 50-60 per cent equity and 40-50 per cent debt with a view towards achieving a balanced growth during a four to five-year period. 3) Aggressive investors : These investors can have 70-80 per cent equity investments along with 20-30 per cent debt investments over an eight to ten-year horizon, targeting higher returns, albeit with higher volatility.

For long-term wealth creation, especially over an 8-10 year period, Desai advocated for a substantial presence in equities, with diversification among large-cap, mid-cap, and small-cap funds. He advised allocating about 35-50 per cent of the equity portfolio to large-cap funds while investing the rest in mid-and small-cap funds to generate higher returns over time.

However, both experts cautioned against common investor mistakes such as chasing top-performing funds or over-diversifying portfolios. Many investors end up holding 40–50 mutual funds, often with overlapping stocks. This not only reduces efficiency but also makes the portfolio difficult to manage. Parashar recommended limiting the exposure to 5-6 mutual funds, which is sufficient to achieve diversification across categories such as large-cap, mid-cap, small-cap, value or hybrid funds, and even international exposure if needed. Flexi-cap or multi-cap funds can also serve as simple, diversified options for investors.

Desai also advised retail investors to avoid excessive exposure to sectoral and thematic funds, noting that these are highly volatile and cyclical in nature. In such funds, both entry and exit timing are crucial, and SIP strategies may not work as effectively. For most investors, sticking to diversified funds is a better approach.

Regarding market fluctuations, the experts emphasized that market declines should not lead to panic selling but rather should continue systematic investment plans (SIPs). During declining markets, investors have a chance to buy more units at lower prices, which can enhance returns over time.

Additionally, they stressed the importance of keeping between 20 per cent to 30 per cent of the investment in debt or fixed income investments like fixed deposits, corporate bond funds, or even government securities. This ensures liquidity and stability within the portfolio.

According to the experts, discipline in investment, right asset allocation, and making decisions without being swayed by emotions are essential to attaining one’s financial objectives. The principle of diversification helps ensure that an investor can participate in all cycles of the market without taking undue risks. If done correctly, it can steadily help build sustainable long-term wealth.