How many funds are "too many" in a mutual fund portfolio?
There is no such number at all. Some people say 3 or 4 funds are enough. Some others say 8 or 9 funds are sufficient. But for me, there should not be any hard numbers in mind while constructing an investment portfolio. One should remember, the more mutual funds one adds to the portfolio, the harder it becomes to manage, difficult to rebalance, and cumbersome to maintain the desired asset allocation.
Every fund should have a purpose in the portfolio
Important to remember that each fund should have a purpose in the portfolio and there should not be more than two funds from each mutual fund category. For example, please avoid having 5 Flexi Cap funds as you are unsure which one will perform in the coming years. You are most likely going to witness 2 among them over-performing, 2 underperforming, and 1 giving a “par” performance at a given time. It is rather better to keep an Index Fund from that category. E.g. For Flexi Caps (NIFTY500), For Large Caps (NIFTY50/100), etc. If you could not show conviction on your selection at bad times then actively managed mutual funds are not for you.
How much diversification is good enough?
As we become adolescents in our investment life, we realize the benefit of diversification across geographies and economies. In today’s day and age, as information is democratized and opportunities are easily available, we tend to start collecting overseas funds. And, it is good to have international exposure for the health of the portfolio, but one should keep a check on the number of funds.
Debt exposure to minimize the risk of volatility
We learn about the Efficient Frontier and rush to the plethora of Debt Fund Categories in an attempt to find a few debt funds to complement our Equity portfolio. After investing in Gilt funds, Credit Risk Funds, and Banking and PSU funds, we finally realize that Short Duration Funds are possibly the best match with Equity. While Debt Funds are a must for any matured investment portfolio as they provide us scope for periodic rebalancing from Equity by periodic profit booking when markets are high and investing when markets are low. However, too many debt funds kept as the vestiges of past innocence make the rebalancing process a nightmare.
Commodity investment as insurance against macroeconomic uncertainty
As we become even more mature and start grasping the dangers of rampant inflation due to the Fed’s money printing spree, and as by now we learned, owning gold can act as a hedge against inflation, we start investing in Gold which is good for the completeness of any portfolio. However, we start investing in Gold in 2 to 3 different ways. E.g. Sovereign Gold Bonds, ETFs, Mutual Funds, etc. Good in spirit but bad for maintenance.
Ideal Portfolio is a Myth
When we start getting familiarized with various investment styles and portfolio construction techniques, we eventually fall into the trap of eternally seeking a better portfolio. Every portfolio will have its day if we are patient. It is meaningless to endlessly chase a mythical ideal portfolio. Smart investors pick a portfolio and stick with it for ages.
Some portfolios are good, some are bad, and some are ugly but the number of funds has nothing to do with it
If an investor owns only 4 mutual funds but they are – two Midcap Funds, one Aggressive Hybrid Fund, and one Balanced Hybrid Fund for an undefined goal say, “Wealth Accumulation”, then it is a sorry state of affair although only 4 funds are there. Because the asset allocation of this portfolio could be hardly determined, it would be impossible to rebalance such a portfolio, and the time horizon is unknown for this investment so difficult to risk profile.
Another investor has a 10-fund portfolio for retirement with 70:30 asset allocation with 2 Large Caps (1 index, 1 active), 2 Multi Caps (1 Index, 1 active), 2 International (1 US Index, 1 China), 3 Debt Funds (2 Short Terms, 1 Gilt) and 1 Gold ETF. This could be a boringly diversified with 10 Fund portfolio but still it is a well-thought-out portfolio construction with some clarity of mind.
It could well happen that the first portfolio with 4 funds could give a better return. But that would not make that hotchpotch first portfolio that no asset allocation or diversification or risk management - a better portfolio. The point is, some portfolios are good, some are bad, and some are ugly but there is no "one size fits all portfolio" that is “Ideal.” and the number of funds has little to do with the quality of a portfolio.
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To summarize, there is no such universal “Ideal” portfolio. The more we get to know about asset classes and understand equity markets, debt markets, international markets, costs, index funds, etc., the more we tend to implement our newly learned skills into our portfolios. Some of these changes are good but overdoing anything is inevitably bad. Having a magical number of funds as a sign of an ideal healthy portfolio is a myth. It is better to look at the portfolio at the overall level and it is useless to have an imaginary magical number of funds in mind and try to comply with that number.
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