One of the most common misconceptions among mutual fund investors is that owning more funds automatically means better
The logic appears sound at first glance. If one mutual fund helps spread risk across multiple stocks, then holding several funds should reduce risk even further. But in reality, there comes a point where adding more schemes stops improving diversification and starts creating duplication.
This is where concepts such as portfolio overlap and overdiversification become important.
Financial experts say that for most retail investors, a portfolio of four to six carefully chosen mutual funds is often sufficient to achieve broad diversification while keeping the portfolio manageable.
What is diversification?
Diversification is the practice of spreading investments across different asset classes, market segments and investment styles so that poor performance in one area does not significantly damage the overall portfolio.
In mutual funds, diversification can be achieved by combining schemes that invest in different segments of the market, such as large-cap, flexi-cap, mid-cap, hybrid, debt or international funds.
The objective is not to maximise the number of funds but to ensure that different parts of the portfolio behave differently under varying market conditions.
A diversified portfolio can potentially reduce volatility and improve the consistency of returns over the long term.
When diversification becomes overdiversification
Many investors assume that if five funds are good, ten or fifteen funds must be better. However, experts caution that excessive diversification can become counterproductive.
According to Bhalchandra Joshi, Chief Operating Officer at The Wealth Company, holding too many funds often leads to portfolio overlap, where multiple schemes own the same stocks or invest in similar market segments.
This can dilute the intended benefits of diversification while making the portfolio harder to track, review and rebalance.
For instance, an investor may own three different believing they are diversifying. In reality, all three funds may hold many of the same blue-chip stocks, resulting in little additional diversification despite increasing the number of schemes.
At the other extreme, an overly concentrated portfolio can also be risky because underperformance by one or two funds can have a significant impact on overall returns.
Understanding portfolio overlap
Portfolio overlap occurs when multiple mutual funds hold the same underlying securities.
Consider an investor who owns a large-cap fund, a flexi-cap fund and a focused fund. While the fund names are different, a substantial portion of the portfolio may be invested in the same companies.
Rishabh Garg, CEO-Digital at FundsIndia, says investors often mistake a larger number of funds for greater diversification.
“Ten funds with 60% portfolio overlap behave like one large bet,” he says. “When that style has a bad year, everything falls together.”
This means investors may believe they have spread risk when they have actually concentrated it unknowingly.
So, how many mutual funds are enough?
There is no universal number that applies to every investor. The ideal count depends on factors such as portfolio size, financial goals, investment horizon and risk tolerance.
However, experts broadly agree that most investors do not need a very large collection of schemes.
Joshi says that in most cases, four to six carefully selected funds are sufficient to create meaningful diversification without unnecessary complexity.
The emphasis, he says, should be on asset allocation, fund quality and performance consistency rather than simply increasing the number of schemes.
A typical portfolio may include exposure across categories such as:
- Large-cap funds
- Flexi-cap funds
- Mid-cap funds
- Multi-asset allocation funds
- Hybrid funds
- Debt funds
Investors seeking global diversification may also consider where appropriate.
Focus on complementary funds, not more funds
Misbah Baxamusa, CEO of NJ Wealth, says investors should avoid the misconception that holding more schemes automatically improves diversification.
According to him, a well-constructed portfolio generally contains a limited number of funds, with each fund serving a distinct purpose.
“Quality of portfolio construction is far more important than the quantity of funds held,” he says.
The goal should be to select complementary funds that work together rather than accumulate multiple schemes that effectively do the same thing.
This approach also makes it easier to monitor performance, maintain asset allocation and make periodic adjustments when needed.
Does the answer change with investor profile?
Investor risk appetite can influence the type of funds held, although not necessarily the number.
For conservative investors, a larger allocation to debt and other relatively stable asset classes may be more appropriate, with equity exposure playing a supporting role.
For aggressive investors with a high equity allocation, diversification across different investment styles becomes more important.
FundsIndia’s Garg advocates a “5 Finger Framework”, consisting of one fund each across five distinct investment styles: Quality, Value, Mid and Small Cap, Momentum or Global, and Growth at a Reasonable Price (GARP).
According to him, different styles tend to outperform at different stages of the market cycle, helping smooth long-term portfolio performance.
“The simple rule is to add a fund only when a new investment style is genuinely missing, not because a new scheme has been launched,” he says.
The bottom line
The number of mutual funds in a portfolio is far less important than what those funds actually own and how they fit together.
For most investors, four to six well-selected schemes are enough to achieve broad diversification. Beyond that, additional funds often increase overlap and complexity rather than improving outcomes.
A disciplined portfolio built around clear goals, appropriate asset allocation and complementary investment styles is generally more effective than a crowded collection of funds accumulated over time.