Document

How to Diversify Investments using Mutual Funds

Updated on: Jan 13th, 2022

|

5 min read

Diversification is one of the most common terms used when it comes to investments. The most straightforward example to understand diversification is by using the case of a cricket team. A cricket team will never have only batsmen or bowlers as all eleven players.

Even the batsmen and bowlers within the team will be of different types. This is because a group requires different skill sets to perform well. Similarly, when it comes to investments, diversification is the ideal method to mitigate risks and allow your portfolio to perform better.

Most investors believe in asset allocation across different categories to achieve diversification. While that is one way to look at it, investing in mutual funds can diversify your portfolio in an ideal manner.

The need to diversify

No investments are immune to market-related risks and will most probably see some amount of fall at some point in time. Over the years, we have seen tech stocks fall when the dot-com bubble burst and financial stocks fall during the subprime crisis.

Even the growth of real estate investments has seen a considerable stagnation in the past few years. You would take a substantial risk by putting all your eggs in one basket, one that can even lead to disruption of your investment goals. While diversification is perceived as a method to reduce your overall risk, it can also provide you with multiple opportunities that you may have otherwise neglected.

You inadvertently invest in asset classes that you are not even comfortable in investing. However, what if you do not have the financial bandwidth or knowledge to diversify your portfolio?

Diversification with mutual funds

Mutual funds are the easiest way to achieve diversification as well as asset allocation without in-depth knowledge of each asset class. By investing in mutual funds that invest in different asset classes such as equity, debt, and gold, you can spread your risks. A sudden change in any macroeconomic condition will not change your portfolio value drastically. So, which mutual funds should you target to diversify your investment?

Equity mutual funds: These funds make investments in the equity market. There are multiple options available that may suit your investment goals and risk appetite. You can go for anyone or a combination of large-cap, mid-cap, small-cap and multi-cap funds. By analysing the portfolio of the equity fund, you can ensure that the scheme you choose invests across industries and asset classes.

Debt mutual funds: These funds invest in a mix of debt securities such as corporate bonds, money market instruments, treasury bills, etc. While offering higher liquidity than traditional FDs, debt mutual funds can even yield higher returns over an extended period. Debt mutual funds are also more tax-efficient, especially when the holding period is more significant than three years, thanks to the benefit of indexation.

Balanced mutual funds: These are hybrid mutual funds that invest in equity as well as debt. Balanced funds are ideal investments for novice investors who don’t want to take on equity-related risks. These funds provide the cushion that comes with fixed income instruments and is the simplest way to diversify.

How many funds can ensure diversification?

This is one of the most common problems faced by investors who understand the importance of diversification. The ideal number of funds depends on factors like your investable amount, investment goals and risk profile. For equity mutual funds, you should not have more than 3-5 funds in your portfolio, which are spread across different market segments and fund management styles.

Investing in a higher number of funds will impair your capability to monitor the funds effectively. Besides, it may also result in repetition of stocks affecting the very basis of diversification. It is worth remembering that diversification is not about numbers, but investing across a range of companies, sectors and asset classes by using mutual funds as the instrument.

inline CTA
Invest in Direct Mutual Funds
Save taxes upto Rs 46,800, 0% commission

Public Discussion

Get involved!

Share your thoughts!

summary-logo

Quick Summary

Understanding the importance of diversification in investments, akin to a cricket team requiring different player types for success. Diversification through mutual funds mitigates risks across various asset classes. Equity, debt, and balanced mutual funds aid in achieving diversification effortlessly. Optimal number of funds for diversification ranges from 3-5, depending on investment goals and risk tolerance.

Was this summary helpful?
liked-feedbackliked-feedback

Clear offers taxation & financial solutions to individuals, businesses, organizations & chartered accountants in India. Clear serves 1.5+ Million happy customers, 20000+ CAs & tax experts & 10000+ businesses across India.

Efiling Income Tax Returns(ITR) is made easy with Clear platform. Just upload your form 16, claim your deductions and get your acknowledgment number online. You can efile income tax return on your income from salary, house property, capital gains, business & profession and income from other sources. Further you can also file TDS returns, generate Form-16, use our Tax Calculator software, claim HRA, check refund status and generate rent receipts for Income Tax Filing.

CAs, experts and businesses can get GST ready with Clear GST software & certification course. Our GST Software helps CAs, tax experts & business to manage returns & invoices in an easy manner. Our Goods & Services Tax course includes tutorial videos, guides and expert assistance to help you in mastering Goods and Services Tax. Clear can also help you in getting your business registered for Goods & Services Tax Law.

Save taxes with Clear by investing in tax saving mutual funds (ELSS) online. Our experts suggest the best funds and you can get high returns by investing directly or through SIP. Download Black by ClearTax App to file returns from your mobile phone.

Cleartax is a product by Defmacro Software Pvt. Ltd.

Company PolicyTerms of use

ISO

ISO 27001

Data Center

SSL

SSL Certified Site

128-bit encryption