What is the best investment for the modern day? This is a question that comes into everyone’s mind; well, there is no one size fits all in this case – that is the very first thing that you have to understand. But, if there is an investment vehicle that could mostly fit into all of the financial goals and objectives – and that is Mutual Funds. You may be wondering how – this is why:
- Mutual funds are flexible in terms of tenure.
- They can match each risk appetite.
- They can be suitable in terms of investment payments (either in SIP or even in bulk.)
- The investments can be big, medium, and small.
- There is every possible industry to choose from.
- The investors can also opt out and opt-in when pleased.
- And much more.
Diversification of your Portfolio
One of the most basic and primary benefits of mutual funds is the diversity provided by the fund. An investor in a mutual fund can essentially hold many securities in a single unit of the fund. This not only spreads the risk of the investment but also allows the investor to optimize their earnings. However, it is vital to recognize that if this benefit of diversification is overused, it can become meaningless or even harmful to your portfolio.
The first step in investing is to conduct research. To make informed investing selections, it is critical to understand mutual funds, their many forms, investment modes, and so on. This will assist you in determining the best form of fund for you. The majority of investors will invest in all of the 15-20 funds that have been shortlisted. This is not the best method and may lead to over-diversification. Over-diversification may result in lower returns because the firm with the best results accounts for a smaller percentage of the portfolio.
Investing in Mutual Funds in India can also be a source of diversification for you since you would be investing across sectors, industries, and much more. Keep reading to understand this part of your investment’s diversification journey.
Investing Across the Boundaries and Differences
As previously said, there are numerous sorts of categories of mutual funds. The most fundamental classifications are debt funds, equity funds, and hybrid funds (a combination of equity and debt).
Investment decisions are significantly influenced by these categories, which take into account the risks connected with each type of fund.
Once this option has been made, the next step is to choose among the many funds available in each category, such as big-cap, mid-cap, and small-cap funds, gilt funds, corporate funds, tax saving funds, and so on.
Many investors make critical mistakes when selecting funds, such as investing in every fund category or purchasing too many funds with the same profile. When evaluating the risk-return correlation, investing in almost every fund category makes little sense because not every category fulfills this correlation or the investment purpose.
Furthermore, when too many funds in the same category are invested, there is no fundamental addition to the portfolio.
For example, if you invest in several large-cap funds, the various options in this category will invest in roughly the same equity stocks, with minor variations in the weightage of such equities. Again, diversification serves no additional purpose.
The Ideal Mutual Fund Portfolio
No fund manager or advisor can tell you how many funds you should have in your portfolio. The optimal approach is to have 6 to 8 funds that match your investment objective and can provide enough diversification while mitigating investment risks. An ideal strategy would be to invest in no more than 1-2 funds from each equity fund type, including large-cap, mid-size, and small-cap funds.
Depending on the risk tolerance, 1 or 2 debt funds or hybrid funds can be added to the portfolio. In any event, most experts agree that an optimum portfolio should contain no more than eight funds from various categories.
Should You Invest in the Best-Performing Funds?
It is a mindset bias – which is a common human trait. It is incorrect to look at past performance and predict future outcomes based on that performance alone.
There is no guarantee that a fund will continue to perform well simply because it has performed well in the past. Similarly, just because a fund has underperformed recently does not mean it will go on to be an underperformer. This is a well-known principle among investors. Nonetheless, we have a proclivity to extrapolate previous performance into the future. Performance must be evaluated in light of its surroundings.
To determine if the same performance could be sustained in the current setting, consider the overall market performance, the economic situation, and the fund’s positioning.
Risk-adjusted performance should be considered. It is a little-known notion. Everyone is aware of it and discusses it, but no one is looking at it. So, don’t pursue performance at the expense of danger.
The underlying securities and fund objective combine to form a fund. Many others take it a step further. They frequently invest in funds that have underperformed in the recent past, believing that the performance would improve. They believe that if a fund is failing now, it will outperform in the future.
Bottom fishing is never a successful investment strategy, whether in equities or mutual funds. Don’t invest solely because the fund is performing well. Similarly, avoid investing in funds that are underperforming. Make an effort to comprehend the performance in context. If you can’t do it alone, engage a consultant.
Investing in more than one mutual fund is always a great deal! Especially when you want to expand your portfolio and grow financially – the best choice is spreading your investments over a wide range of mutual funds.