The reason should be obvious. How many funds do people actually invest in? You’ll be surprised. Looking at the patterns of aggregate data of many Indian mutual fund investors, it turns out that most had more than 10 funds, 20-30 were not uncommon, and more than 50 was unusual but not rare. Most investors who had less than 10 or so funds have been investing only for a few years. No doubt, as time passes, their collection will also grow more impressive. Why do people invest in so many funds? Their polite reason is diversification, but the real one is sales pressure. Everyone knows— at least should know—that diversification is a safeguard against the underperformance of a group of investments. By allocating only a small portion of your funds to a specific company, sector, company size, or even geographical area, you mitigate the impact of its potential underperformance compared to the broader market. However, diversification offers little protection when the entire market experiences a downturn.
Most investors invest in too many funds because someone sells it to them and earns a commission. The investor does not have a clear view of diversification and thinks that more funds are good. It’s not just a question of there being no benefit from investing in more funds, and it’s actually detrimental. Having too many funds in one’s investment portfolio devalues one major advantage of investing in mutual funds, which is the convenience of tracking and evaluating one’s investments. Having investments in a large number of mutual funds makes this exponentially more difficult.
So, returning to the original question, what about investing in a single fund? What type of fund should it be? Given that equities are considered the most effective long-term investment, and mutual funds provide a convenient and secure method for investing in equities, it is logical to conclude that selecting an equity fund would be the optimal choice for such an investment, and the actual type should be tax-saving funds, and then hybrid funds. The long-term perspective is emphasised in tax-saving funds due to tax regulations that require a minimum lock-in period of three years. This lock-in helps investors achieve good returns and avoids short-term panics that can impact inexperienced investors in other equity funds.
Inexperienced investors often enter equity funds when the market is high and exit when it drops, which is blocked in taxsaving funds. Then, after fulfilling your tax-saving requirements, hybrid funds become the ideal next step in your investment journey. Since investors should have a balance of fixed income and equity investments, hybrid funds work well as all-in-one, one-stop investments. I’m sure readers would have noticed that from saying ‘one fund’, I have quietly transitioned to one type of fund. That much diversification is needed. The sweet spot for the ideal number of funds tends to be three or four; anything more is a waste of effort. The simpler your portfolio, the easier it is to manage, understand and get good returns out of.
(The author is CEO, VALUE RESEARCH.)
