Holding too many mutual funds reduces gains

Should you invest in multiple mutual fund schemes from different mutual fund houses?

India has more than 3000 mutual fund schemes running today across various categories – equity, debt, hybrid, sectoral, etc. Most of us invest in at least 4-5 different mutual fund schemes. Some invest in even more than 10 schemes.

One of the biggest reasons for doing this is that we feel that we are diversifying our capital. Basically, if one of the schemes performs badly, I will make up for it in the other schemes. In this article, I would like to show that this might not be the most optimal path and in fact holding more and more equity schemes might lead to mediocre performance in the long run.

How does an Equity scheme works?

Most of the equity schemes in India invest in at least 40 different stocks. Other than schemes focusing on only one sector (sectoral funds - which you should anyways avoid), most funds ensure that their portfolio is already well diversified. Fund managers invest in multiple sectors across multiple companies to ensure that even if few companies perform badly, the overall portfolio is not affected.

Lets take the example of HDFC Top 100 Fund, one of the largest equity mutual fund schemes in India.

This scheme has invested in 52 different securities across multiple sectors! Surely, the Fund manager has already ensured all the necessary diversification that might be needed.

Why adding more mutual fund schemes wont lead to additional diversification?

As explained above, most of the equity schemes are well diversified by design. In fact, it has been proven through research that holding more than 20 stocks does not lead to additional diversification.

To understand this better, lets look at the below graph.

As you can see, almost all mutual funds schemes move in tandem. No matter whether you have 3 different large cap schemes or a combination of large/ small cap schemes, if the markets are going down, all schemes will go down.

High degree of overlap

When you are investing in multiple schemes, it leads to a high degree of overlap as well since all mutual funds ultimately invest in the same universe of stocks.

This can be visualized from the snapshot below. If you own multiple schemes, you still end up investing in the same stocks. No additional benefits at all.

You literally end up owning all the stocks

Here’s the biggest problem. When you invest in 5-6 schemes, you end up owning literally all the stocks available. Even with 5 schemes, you would end up with at least 200 stocks.

Your investment in each stock would be so small, that ultimately, in the long run you would end up with only average returns.

Buying plenty of mutual fund schemes only benefits financial intermediaries 😊

The right way to invest in mutual funds

The key is to invest in 2-3 extremely high-quality equity schemes, avoid overlap as much as possible and stay invested for long periods of time to enjoy healthy compounding.

Please note, the scope of this article is limited to equity schemes only. These principles completely change when you are investing in debt funds. In fact for debt schemes, the more the merrier.

Investing is all about growing capital. As long as even two mutual funds are growing at 14-17% annually, that’s all you really need.

So, how many schemes do you own?