How To Build a Diversified Mutual Fund Portfolio?
April 19, 2023
One of the least talked about points of constructing a mutual fund investment is diversification. Diversification is a core tenet of investing that ensures you get optimum returns from your mutual fund investment and effectively tackle the associated volatility. Mutual fund portfolio diversification happens when you add funds with multiple characteristics where your corpus is appreciated and protected simultaneously.
Ways to Construct a Diversified Mutual Fund Portfolio
1. Invest Across Asset Classes as Per Your Requirements
At a basic level, your portfolio must be spread across asset classes like equity, fixed income, and gold. Mutual funds offer a whole host of funds within each asset class, making it a large universe to choose from. Factors such as investment goal, investment horizon, risk appetite and return expectations should make it easy to decide the asset allocation and select the suitable fund for your portfolio. For instance, if your goal is 15 years away, the portfolio can have higher exposure to equities. Likewise, the portfolio should have more debt funds if the goal is to purchase a car in the next two years.
2. Look at the Fund’s Core Holdings
It’s not uncommon to find investors investing in multiple schemes for the sake of diversification only to own schemes with similar portfolios. On paper, it may seem like diversification. However, it is not. The schemes may vary, but there may not be much diversification at the individual security level.
3. Have Funds from Different Fund Houses in Your Portfolio
Another layer of diversification can be added by investing in funds from different fund houses to benefit from a variety of investment strategies. Some follow an aggressive investment style, and some stick to a more conservative pattern. Similarly, fund houses have their strength – some are good with stock picking, some are good with market cycles, some are adept at picking large-cap stocks, and some are experts in spotting the multi-baggers.
4. Invest in Thematic Funds Selectively
Thematic funds aim at potential investment opportunities related to a specific sector or a theme. Examples include funds that focus on companies involved in clean energy or renewable resources or a fund that bets on companies that are leaders in artificial intelligence.
5. Contemplate Investing in Index Funds
Another prudent way to build a diversified mutual fund portfolio is to invest in index funds. Their objective is to replicate the index they are mimicking by owning stocks in the same proportion. They are passively managed and, unlike actively managed funds, don’t try to generate alpha. Being passively managed, their investing cost is lower than actively managed funds.
A mutual fund portfolio comprising four to five different funds within each asset class, aligning with your goals and risk appetite, is good enough to achieve the desired diversification. Too many funds can bloat your portfolio and make it difficult to track. Review your portfolio once every six months to see your funds’ performance. Weed out laggards if they have underperformed for an extended period and replace them with better-performing funds.