How many mutual funds should I buy?

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Published: October 5, 2021 at 8:27 am

Last Updated on October 16, 2021 at 5:22 pm

Abhishek asks, “Dear pattu sir, how many mutual funds are necessary to build a portfolio? I would like to build a long-term minimalistic but diversified portfolio”.

Ironically, context is often the first casualty in personal finance discussions. If you go to Facebook group Asan Ideas for Wealth and announce, “I am holding ten mutual funds”, you will get all sorts of responses: From “too many funds”, “too much overlap” to “start day trading”. Few members would bother to ask for more details.

The number of funds we hold depends on our experience, networth, clarity, ability to control FOMO, etc. Today it also seems to depend on where we started investing. Let us consider instances of each case.

Take, for example, my mutual fund portfolio. It has a total of nine funds (six equity funds to two goals, one gilt fund, one liquid fund, one arbitrage fund), and I am thinking of adding one more. Does that look like too many funds? Not from where I sit. I have often mentioned that my equity MF portfolio is the residue of my mistakes.

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As a new investor, I made classic mistakes like starting a second ELSS sip instead of investing more in the first ELSS fund. Except for Parag Parikh Flexicap Fund, which I started investing in from its NFO stage, I don’t think I could ever justify any of my past or current MF holdings.

It seems to have taken a lifetime to reduce the no of equity funds to a reasonably small three per goal (I am not a fan of the unified portfolio approach), but I may need to add one more equity fund. Why?

Ask yourself, what is the maximum that you would invest per fund, per AMC? Is it Rs. 10 lakhs? Rs. 50 lakhs? Or is it Rs one core? Naturally, this is a personal definition, but you need to add another fund to reduce concentration risk once this limit is breached. And I will need to do this in the coming months. This does not mean my portfolio is cluttered or I have lost focus (I never had it to lose it). It is merely a necessity.

Few investors would appreciate this if a person says, “I have ten funds – five large caps and five mid caps”. It is possible that each fund could have an amount close to the investors personal per-fund limit.

Information such as the number of funds an investor holds or what they are is useless unless we appreciate context. For example, Asan Ideas for Wealth members are eager to ask Ashal Jauhari, “how many funds do you hold?” and what they are. But they are not interested in asking, “what is your asset allocation?” Simplicity in personal finance is personal!

Today, new mutual fund investors are spoilt for choice, and it reflects in their portfolios. Many robo advisory portfolios recommend 5-10 funds for a total investment of Rs. 5000 per month. Can we apply the “personal finance is personal” card here? Yes. I suppose new investors are not comfortable with investing the entire Rs. 5000 in a single fund or two funds.

Fair enough. As long as this “diversification” is not done in the name of “averaging”. A distinction needs to be made between personal comfort and personal beliefs. Many investors believe or want to believe that what they do is right. I am afraid real life is a lot more complicated than that!

Even if we ignore the investment limit per fund, the number of mutual funds to build a minimal equity portfolio is quite arbitrary (these are examples and not recommendations)

  • Sensex index fund
  • Nifty and Nifty Next 50 index funds
  • Aggressive hybrid funds alone
  • large cap fund plus midcap fund plus small cap fund plus international equity fund
  • large cap fund plus midcap fund plus small cap fund plus + international fund + sector fund + smart beta fund

We could go on and on. The division between diversification and diworsification is quite arbitrary. This is because most investors (and even some advisors) cannot quantify the degree of diversification in a portfolio. Worse, they don’t care to do it but will be quick to sit in judgement on others portfolios.

We will need to measure “minimalism” taking personal preferences and circumstances into account instead of just a high or low number. In summary, investing is fundamentally belief-based and context-based. If you are clear about the number of funds required to satisfy your needs and wants, then that is the correct number of funds. We need to define portfolio clutter by the degree of our confusion, not the number of funds.

So Abhishek will first need to be clear on the mix of funds in his equity and debt portfolio. There is no ideal number and there are different routes to achieve success. It is only a matter of conviction and discipline.

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