How To Design A Well-Diversified Mutual Fund Portfolio

Mutual fund investments offer the potential for good market-linked returns over time, but also carry certain investment risks. Diversification is a cornerstone principle of MF investing that helps manage these risks. Diversification is the act of spreading your investment across asset classes, sectors, and industries to minimise their risk exposure and optimise their return potential. However, designing a well-diversified mutual fund portfolio can be a challenging task since you also risk overdiversification by including too many instruments and schemes in your portfolio. Therefore, it is tight-rope for most investors. This article offers a guide on how to design a well-diversified mutual fund portfolio to reach your goals faster in a risk-balanced way.
 

Looking for an easy fix to your diversification struggles? Here’s a list of 5 easy hacks to design a well-diversified mutual fund portfolio:
 

Understand the asset allocation of portfolio

Any investor’s diversification strategy is based on factors like your age, risk tolerance capability, and return expectation. For instance, the 100 minus age thumb rule is often invoked to ascertain asset allocation for investors of different ages. If you are a 30-year old investor, you should invest 70% (100-30) of your portfolio in equity funds. Conversely, if you are a 55-year old investor, 45% (100-55) of your portfolio should be equity investments. Apart from asset class variation, you must also ensure diversification within that particular asset class. Taking the previous example forward, if you have 70% invested in equity, your investment should be spread across different equity-oriented mutual fund schemes covering larger, mid, and small-cap funds as per your risk parameters and financial goals. Your asset allocation proportions among various asset classes should change with changes in your age, goals, and risk appetite.

Ensure variation in stock holdings

A pivotal tip to design a well-diversified mutual fund portfolio is to check for diversification in the underlying equities. In simple words, you should closely review the stock holding of your selected MF schemes to see if their stock holding patterns are identical or different. If you own two MF schemes that invest in the same stocks, the diversification quotient of your portfolio may be compromised. Whenever the market is volatile, returns from both schemes will take a hit because they invest in the same stocks. It is always prudent to invest in schemes with low overlap between stock holdings to improve your risk-reward spread and ensure optimised diversification.

Invest in funds from different AMCs

You must have often heard the phase ‘don’t put all your eggs into one basket’ in the context of mutual fund investments. While this applies to investing in asset classes and schemes, it is also applicable to asset management companies (AMCs). Mutual fund managers employed by different AMCs have differing management and investment styles. If you keep investing in MF schemes from the same AMC, your risk-reward ratio may flatten because every time the fund manager’s approach to a certain situation would be the same. Alternatively, if you invest in MF schemes from different AMCs with different fund managers, you have better chances of averaging out their performance when the market turns volatile. This is a strategic way to design a well-diversified mutual fund portfolio that meets your return expectation without compromising your risk exposure.

Diversify investments across time horizons

Time horizon also plays a crucial role in helping you design a well-diversified mutual fund portfolio. You should consider diversifying your portfolio with MF investments across different time horizons. For instance, you can choose debt mutual fund schemes for short-term goals that need to be fulfilled in 1-3 years like planning a foreign vacation. However, equity schemes can be reserved for long-term goals like retirement planning that require an investment horizon of 10-15 years. Diversifying across time horizons will help lower the risk exposure of your overall portfolio while ensuring regularised liquidity to meet your financial needs.

Diversify across underlying benchmarks

Every MF scheme also has its own benchmark like the CNX 50 or BSE 100. It is also mandatory for MF schemes to declare the index against which it is benchmarked. The risk quotient of the scheme varies depending on this underlying benchmark. To design a well-diversified mutual fund portfolio, you should ideally invest in funds with different underlying benchmarks.

• Ensure an optimised asset allocation for your portfolio based on factors like your age, financial goals, risk tolerance, and return expectation.
• Check for variation in stock holdings and underlying benchmarks in MF schemes.
• Avoid investing in schemes from only one AMC and diversify your investments across different time horizons.

Curating a well-diversified mutual fund portfolio is not a one-time exercise, but rather a constant process. It is crucial to review your investment portfolio at least once a year. Your MF portfolio may move away from the target asset allocation due to market volatility requiring rebalancing from time-to-time. This rebalancing ensures that your portfolio always aligns with your changing goals and risk profile. If you feel unsure about your diversification strategy, it is always prudent to seek help from a professional advisor.

Now that you know how to design a well-diversified mutual fund portfolio, you can get started with your investment journey through the Bajaj Finserv Mutual Fund Platform. On this smart platform, you can compare 1000+ MF schemes and review their performance against benchmarks to make an informed choice. You can also estimate returns using a Mutual Fund Calculator tool to create a well-rounded investment plan.