Have you ever heard of the old adage, “Don’t put all your eggs into one basket?” This ideally underlines the importance of portfolio diversification when you begin investing money.
Having a diversified portfolio of investments is very important to gain positive, inflation-adjusted and risk-adjusted returns on your investments.
But, when it comes to a diversified portfolio, how many Mutual Funds would be considered ‘ideal’? Defining an ideal number of Mutual Funds to have in your investment portfolio is dependent on a few specific factors. Let’s decode those factors for you with these questions.
What is your investment objective?
For many investors, the reason for their investments is long-term wealth creation or to build a retirement corpus. Some investors may be investing to have a source of regular income. They could be exploring monthly income plans. Other investors are more conservative and wish to preserve their money, opting for capital safety over growth or risk to their investments.
Once you set your investment goals, you will be able to decide on a suitable asset allocation for your investments.
Additional Reading: Term Of The Week: Asset Allocation
What is your risk tolerance?
Risk tolerance is a rather common term in the world of investing. It is a measure of an investor’s comfort with market volatility. It defines how you react to periodic fluctuations in the markets with respect to your investments.
If you are the adventurous sort of investor, you may be willing to hold on tight to your investments in volatile Mutual Funds during a bear market.
If you are unsure of your risk tolerance, we are here to help you with a simple risk tolerance questionnaire.
A risk tolerance questionnaire is usually used to assess an investor’s level of comfort with the effect of market risk on their money. A risk tolerance questionnaire categorises investors as aggressive, moderate or conservative.
Take a shot at it and see where you stand.
Additional Reading: Evaluating Risk Tolerance And Appetite
- You wake up one day to find that the stock market has crashed by 10%. Your investments are down by 15%. You
- Sell all your investments.
- Contact an investment adviser to check if you need to sell any of your investments.
- Wait for a few days to see if the market will recover.
- You have invested in stocks and equity Mutual Funds to buy a house. Your goal is 2 years away. Your investment adviser says markets might go up this year. You
- Move your investments to safer avenues right away.
- Wait for a year to move your investments to safer avenues.
- Hold on till your investment adviser says it is okay to move your investments.
- You invested a large amount of money in a penny stock. The stock has sunk by 15% due to bad news in the industry. But, you know that the company is a strong one and will do well in the long run. You
- Sell the investment anyway.
- Wait for a few days to find out how bad the news is.
- Hold on to the stock.
- During a market slump you
- Sell loss-making investments.
- Check to see if you can buy good stocks at low prices.
- Add more stocks to your portfolio.
- I invest in Equity Mutual Funds based on
- What my investment adviser tells me.
- What my friends tell me.
- My own research.
If you have attempted to answer the risk tolerance questionnaire we put together for you, we can tell you what type of investor you are.
If you have answered with option ‘A’ to most or all of the questionnaire’s questions, you are probably hesitant of experimenting with your money and you prefer to put as much distance as you possibly can between your money and market risks. You are a conservative investor.
If you have answered with option ‘B’ to most or all of the questions, you are probably not completely risk averse. You don’t particularly lose too much sleep over minor market fluctuations and are open to taking a moderate level of risks with your investments. You are a moderate risk investor.
If you have answered with option ‘C’ to most or all of the questions, you probably pride yourself as an expert on everything about investments. You are an adventurous sort of investor and are not afraid to take considerable risks with your finances. You are an aggressive investor.
Additional Reading: 5 Risks You Should Be Aware Of As An Investor
Consider risk capacity too
Assessing your risk tolerance is all well and good, but it may be rather unwise to be bold and brave and take unnecessarily high risks with your investment corpus just because you want big-ticket returns. You also need to take your risk capacity into consideration.
Risk capacity? What’s that?
Risk capacity is simply the level of risk you can comfortably afford to take on your investments. You may be willing to shoulder high risk, but if your investment goals are close at hand, or if your investments are for the short-term, you will do better to tone down the risk factor and opt for a more conservative portfolio.
Additional Reading: Rebalance Your Portfolio For Best Returns
Let’s get you started with portfolio diversification
Building a successful investment portfolio is easy. It doesn’t have to be a herculean task. It is wise for investors to create their own investment portfolio and manage it based on their specific financial needs. Here’s how you can go about it.
On a primary level, there are two main Mutual Fund categories – Equity Mutual Funds and Debt Mutual Funds.
If you have a moderate or high-risk appetite and are aiming at achieving long-term growth with your investment, equity will be suitable as the predominant asset class. The invested amount requires growth & capital appreciation, and the investment horizon will be long enough to mitigate short-term volatility in equity.
In case, an investor is saving for a short-term goal, the portfolio would need to have debt as a predominant asset class in order to enable a small but stable growth in the invested amount.
Additional Reading: All About Risks In Debt Funds
If you find that you may need access to the invested money at short notice, investing in Liquid Funds is a good option.
Need an example of a suitably diversified investment portfolio? Let us help you there.
- Large-cap Equity Mutual Funds: 40%
- Small-cap Equity Mutual Funds: 10%
- Foreign Funds: 15%
- Intermediate Term Bonds: 30%
- Cash / Money Market Funds: 5%
This allocation is appropriate for an investor who is willing to remain invested for the long-term and has a moderate risk tolerance.
Simply put, the asset allocation is 65% in equities, 30% in debt instruments and 5% in cash and money market instruments.
Additional Reading: Introduction To Equity Mutual Funds
How much money do you have to invest in Mutual Funds?
It’s time you busted the myth that says you need to have a large sum of money to begin investing in Mutual Funds. That simply isn’t the case. Mutual Funds have a low minimum investment threshold. In fact, it’s as simple as opening a Savings Account, only much more rewarding. You can begin investing in Mutual Funds with as little as Rs. 500.
Additional Reading: How Important Is A Well-Diversified Portfolio?
So, how many Mutual Funds is ideal?
Generally speaking, that the ideal number of Mutual Funds you should invest in for a well-diversified portfolio is between three and five funds. However, it really depends on your financial situation and your goals at the end of the day.
Investing in Mutual Funds is easy and can be highly rewarding. Make a wise choice. Begin investing today.