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Mutual funds come with a wide range of benefits for investors. If you have invested in these financial products, or if you are considering it, you are perhaps aware of how mutual funds work. For the uninitiated, however, here is a quick overview of what mutual fund investments are.

What are mutual funds?

Mutual funds are investment vehicles where capital from a group of investors is pooled together. These common funds are then invested in different kinds of assets such as equity, debt instruments, money market instruments, or even gold. Depending on the kind of assets they invest in, we have different kinds of mutual funds.

Here is a list of the most common types of mutual funds.

Equity funds

These mutual funds primarily invest in equity stocks. Based on the kind of stocks they invest in, equity funds can be large-cap, mid-cap or small-cap funds.

Debt funds

Debt funds mainly invest in debt instruments like government bonds, corporate bonds and other fixed income debt securities.

Money market funds

Money market funds, as you may have guessed, invest in money market instruments like T-bills and certificates of deposit.

Hybrid funds

Hybrid funds invest in a mix of stocks, bonds and other assets. The ratio can be fixed or variable.

Tax-saving funds

As the name indicates, these mutual funds offer tax benefits. They are also known as Equity Linked Savings Schemes (ELSS), and they invest primarily in equity stocks.

Can you have too many mutual funds in your portfolio?

Mutual funds invest in a wide range of assets, even if only within a specific category. For instance, take the case of a large-cap equity fund. While this investment vehicle will undoubtedly invest primarily in large-cap stocks, the stocks may belong to companies operating in different sectors. So, this brings a certain level of diversification to your portfolio right away.

This naturally goes to say that the more mutual funds you have in your portfolio, the more you can diversify your portfolio. And diversification is a good thing - until you go overboard with it. Each equity mutual fund, for instance, invests in around 50 to 60 stocks. So, if you have 10 mutual funds in your portfolio, you have over 500 stocks.

Too much diversification such as this can be detrimental to your portfolio because it can drag down the overall returns, without reducing the overall risk as much. So, the long and short of it is this. Yes. You can have too many mutual funds in your portfolio. And yes, it is a problem. Let’s see why.

Why is it never a good idea to have too many mutual funds in your portfolio?

Having too many mutual funds in your investment portfolio comes with its own pitfalls. Here is a closer look at the key reasons it is never a good idea to invest in too many mutual funds.

You will find it harder to manage your portfolio

If you have too many mutual funds in your portfolio, you will soon find it hard to keep track of how your capital is distributed across different asset classes. Your mutual fund investments may also start to overlap, since certain stocks or securities may be common in different funds.

You may make some poor investment choices

In a bid to include as many mutual funds as possible, you may make some poor investment decisions and choose some funds that are not of the best quality. For instance, you may choose a fund that comes with too many charges, or a fund that has a less skilled fund manager.

It brings down the overall quality of your portfolio returns

More importantly, having too many mutual funds pulls down the overall returns that your portfolio can deliver. Your capital will be diluted across too many assets, so the returns from the best performing investments may be set off by losses from poorly performing assets.

So, how many mutual funds should you hold?

Let’s get the truth out of the way first. There is no magic number. That said, it is financially advisable to limit the number of funds in your portfolio to three or four MFs. You can choose to diversify across debt and equity. Or, if you want to primarily choose equity MFs, it is a good idea to have a couple of flexi-cap or multi-cap funds along with a large-cap or a mid-cap fund, depending on your financial goals.

Limiting the number of mutual funds to a more manageable number also makes it easier for you to research the investment vehicles thoroughly before you invest in them.

A step-by-step guide to overhaul your portfolio

If you have unfortunately already invested in too many mutual funds, you may understandably be worried about the above issues. However, it’s quite easy to revamp your portfolio even now. You just need to follow the steps outlined below.

Step 1: Identify the underperforming mutual funds and disinvest from them.

Step 2: Decide on the ideal asset allocation for your portfolio based on your financial goals.

Step 3: Choose 3 to 4 top performing mutual funds based on your preferred asset allocation.

Step 4: Rebalance your portfolio and allocate the capital across the chosen funds as needed.

That’s all it takes to clean up your portfolio! And once this is done, make sure that you revisit your portfolio every few months to track the performance of the investments and keep an eye on your asset allocation.

Summing up

If you are having trouble cleaning up your mutual fund investments, you can always seek assistance from financial experts. This can help you rebuild your portfolio in the optimal manner. Remember to give your financial advisor all the details about your financial goals - like the timeline, the amount needed and the funds you already have set aside for them. This can help the professional help you better.

Mutual fund investments are subject to market risks, read all scheme related documents carefully before investing.