How do diversified mutual funds contribute to investment success

Imagine you are on a vacation and you wake up to bread and butter instead of a lavish buffet breakfast spread. The disappointment would be real and justified. Luckily, you don’t have to worry about variety and diversity when it comes to investing in mutual funds.There are several advantages of mutual funds, and diversification is one of them.

Find out more about diversified mutual funds. 

Understanding the real meaning of a diversified mutual fund portfolio

A portfolio of diversified mutual funds includes different mutual fund schemes that invest in different securities. These securities can be from different asset classes or even otherwise. When you invest in different funds, you create a cushion against volatility.

The primary motive of diversified mutual funds is to not put all your eggs in one basket.

Since two or more funds are unlikely to react or perform in the same manner, your investments are able to build immunity against market highs and lows. If one sinks, the other could stay afloat, and your overall returns would be stabilised. 

There are different types of mutual funds you can invest in. The three main categories include:

Equity mutual fund: These funds invest at least 65% of their assets in equity or equity-linked securities. These are on top of the list as far as risk is concerned. Their returns are also relatively higher than other types.

Debt mutual fund: Debt funds invest in fixed-income securities such as corporate bonds, treasury bills, commercial papers, government securities, etc. The risk is the lowest of the three.

Hybrid mutual fund: Hybrid funds invest in equities and debt. However, the concentration can differ. Conservative hybrid funds invest 75% to 90% in debt securities and the remaining in equity. Aggressive hybrid funds invest 65% to 80% in equity securities and the remaining in debt. Balanced hybrid funds maintain a maximum and minimum of 60% and 40% in debt or equity. There are also balanced advantage funds that have the flexibility to invest 0 to 100% in equity or debt based on market conditions. For example, such a fund may choose to maintain equity exposure between 30% to 80%. If you are a beginner, balanced advantage funds may be ideal for you because their dynamic asset allocation can help you tackle market volatility.

Less is more or more is less – How much money can you invest in each category?

The simple answer is whatever suits you and your finances. However, it is essential to understand that an equity mutual fund may carry the highest risk out of all but also has the potential to earn the highest yield. So, this may be suitable if you have a high risk appetite and a long term ahead of you. On the other hand, a debt mutual fund carries low risk and comparatively lower returns. It can be used for short-term goals or if your goal is capital preservation and not appreciation. 

If you are confused about how much to invest in each, you can consider subtracting your age from 100. The result can be your equity allocation, and the remaining can be invested in debt. For instance, if you are 30 years old, you can consider investing 70% of your investment budget in equity and 30% in debt. This is known as the ‘100 minus age’ thumb rule of asset allocation.

While allocating your money, you can also diversify within asset classes. For instance, if you are investing in an equity mutual fund,you can consider large, mid, small, and flexi-cap funds or ELSS (Equity-Linked Savings Scheme) for optimal diversification. 

It is crucial to strike the right balance while diversifying your portfolio. If you over-diversify, you may find it hard to monitor all your mutual funds. This can ultimately harm you.

The real deal: How can diversified mutual funds help?

Diversified mutual funds can cut down risk from your portfolio by exposing you to different asset classes and securities. This can contribute to better growth and more investment success, too. It also helps you learn different investment strategies and get a sense of what works the best for you and your goals. 

Example of diversified mutual funds portfolio

Let us consider a simple example to better understand the concept and benefits of diversifying your mutual funds portfolio. When Rishabh, a 35-year-old IT professional began his investment journey five years ago, he decided to build a diversified mutual funds portfolio, having understood the importance of diversification in managing risk and maximising potential returns. Accordingly, Rishabh carefully selected a range of diversified mutual funds across different asset classes and investment strategies.

This mutual funds portfolio helped him optimise returns and reduce risk by allocating a portion of his corpus to equity funds, which offer growth potential but also higher volatility and balancing it with bond funds which unlock stability and a regular income. He also focused on sector diversification within his mutual funds portfolio by including schemes investing in different sectors and industries such as technology funds, healthcare funds, and funds focused on the manufacturing industry. By spreading his investments across various sectors, Rishabh managed to reduce the risk associated with overexposure to a specific industry.

To round off his portfolio, Rishabh also invested in international mutual funds, which invested in companies outside India, thus gaining exposure to different economies, currencies, and market trends and thereby, reducing reliance on a single market.

Conclusion 

Diversification in mutual funds is of critical importance. So, try not putting all your eggs in one basket and instead enjoy some gourmet breakfast!

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