How many mutual funds should I hold?

Published: May 3, 2014 at 9:30 am

Last Updated on

Most freefincal readers would be familiar with this question and perhaps more familiar with the answer – do not hold more than 3 or 4 funds. More funds do not mean higher diversification!

So why bother writing another post on this?

In academia, we have a saying: there is no such thing as a dumb question but there is definitely such a thing as a dumb answer!

When it comes to personal finance, perhaps the more appropriate adage is, ask a piece-meal question, you get a generic answer. Ask a holistic question, you get a holistic answer.

“Do  not hold more than 3 or 4 funds. More funds do not mean higher diversification” represents a generic answer to a generic question.

Since personal finance is excessively personal, asking generic questions and taking the ensuing generic answers seriously is waste of time and effort.

So most often, the trouble is with the question.

‘Which is the best health insurance plan?’ is a generic question.

‘Which is the best health insurance plan for me?’ is a holistic question.

‘Experts’ and enthusiasts most often deal with generic questions all the in the name of financial literacy.

Only the individual in question can answer holistic questions!

So what is the holistic question in this case?

To answer this, let consider  the case of Calvin’s dad who works as a patent attorney.  His Son Calvin is a 6 year old (with a certain stuffed toy!).

Calvin’s dad, let us call him Bill(!), started investing for retireDadment about 12 years ago via SIP in a diversified equity mutual fund. After Calvin was born, that is six years ago, he double the SIP amount to fund Calvin’s education.

Calvin will finish school after about 11 years, while Bill will retire after 20 years.

Bill believes a single mutual fund is enough to serve as the equity component for both retirement and Calvin’s education.

He expects 12% returns for his retirement goal and 10% for Calvin’s education.

First, here is a question for you: How much should Bill withdraw from the fund when (that is a little before) Calvin finishes school? The idea here is withdraw for Calvin’s education without touching the retirement corpus.

Catch my drift?

Now, what is the holistic question that involves the number of mutual funds one should hold?

Crude version of the holistic question: Bill should ask himself, I have two long term goals: my retirement and Calvin’s education. How many mutual funds should I hold?

Let us try to answer this:

To simplify things, let us assume a single equity oriented balanced mutual fund is enough to build a diversified portfolio for long-term goals.

Bill retirement and Calvin’s education are events that are expected to occur 9 years apart in time. That Calvin will graduate after 11 years and Bill is slated to retire after 20 years.

Let us first recognize that long-term or short-term, the risk-profile of the goal

  • how important is it?
  • how far away is it?
  • what is the reasonable rate of return expected from a diversified portfolio? Etc.

is more important than the risk appetite of the investor

  • how much risk can Bill stomach?
  • Does he understand how equity holdings compound? and the typical kind of psychobabble used for risk profiling!)

Should Bill assume that the risk-profiles of the two goals, that differ by almost a decade in tenure, to be similar and use the same mutual fund for both goals?

Should bill use the same asset allocation (equity:debt ratio) for both goals?

Assuming the risk-profiles are similar (they are not!), what if Bill chooses to increase the monthly investment amount for each goal each year? What if this percentage increase is different for different goals?

Would it become easier to evaluate how much Bill should withdraw?

What if Bill had chosen to use 2 equity funds and 2 debt funds for retirement and chose to contribute more in each of these funds for Calvin’s education? He adjusts the contribution amount to initially match the asset allocation for each goal? Would it now become easier to evaluate how much Bill should withdraw?

Bill would then like to rebalance each year to ensure the asset allocation for each goal does not deviate too much from his original plan.  Can you please chalk out a way in which Bill can rebalance? Is rebalancing easier with fewer funds? Note that the idea here is to rebalance without mixing the corpuses!

I have assumed Bill never  changes his funds. Would it make things easier if fund changes are included?

Well, enough fooling around. Let us get to the central issue.

Exact Version of the holistic question: Assuming Bill builds a diversified equity portfolio with say, 3-4 mutual funds, can he use the same funds for all his long term goals? Or should he have separate portfolios for each long term goal with a few funds in each folio?

  • Can Bill use the same portfolio for all long term goals so that the number of funds is kept to a minimum? This way, can he ensure that he does not mix the corpuses during rebalancing and the final withdrawal?

YES. Of course he can! Only because anything is possible! Would take some doing though. If you answer the above questions, you can check for yourself how easy it is!

  • Is it practical to use the same funds for all long term goals just to keep the number of funds small so that it is ‘easier to manage’?

NO.

Put yourself in Bills shoes and seek your own holistic question first and the seek the holistic solution.

As for me, I have 3 long term-goals: retirement, my son education and his marriage. Each of them have different tenures, different return expectations and therefore different asset allocations.

I use separate mutual fund portfolios for each of my goals. This makes it easier to know the corpus value, net folio returns, rebalance etc.

I use the automated mutual fund and financial goal tracker to check my holdings and net portfolio returns.

People say it is tough to manage multiple funds. I don’t know what the fuzz is all about. Choose funds with a long history of decent performance and give it at least 5 years to perform. Don’t be worried about short term performance and stay invested. Monitor frequently but do not act unless absolutely required.

So far the only redemptions I have made are from ELSS holdings done years ago and for rebalancing. It takes less than 20 minutes to invest in them each month. If you are running a SIP, you save on that as well.

I review a fund with the automated rolling returns calculator or mutual fund returns analyzer only if there is a significant drop in performance. Even then, if the fund is doing well wrt to its benchmark and I have faith in the fund managers ability, I have done nothing (for e.g. see review on HDFC Top 200). The equity portfolio overlap checker helps me keep my portfolios reasonably diversified.

As far as I am concerned, dedicated portfolios for long-term goals is far more hassle-free. I know exactly how much to rebalance each year and withdraw from a corpus when the goal is due!  I get a clear picture of the net portfolio growth and take corrective actions as and when necessary.

If we use the same funds for all goals, then the fate of all the goals hinge on the same funds. If each goal is separated by several years can you find anything smart about such a strategy?

Confusing a generic answer with a holistic one is injurious for fiscal health. It is not about the number of mutual funds that one should hold. It is about the number of long term goals that one has, and seeking out the most efficient way to manage them.

Picture courtesy: Scienceteacherresources.blogspot.in

Do share if you found this useful
Share your thoughts on this topic at the  Reddit freefincal_user_forum

Reach your financial goals like a pro! Join our 1600+ Facebook Group on Portfolio Management! You can now reduce fear, doubt and uncertainty while investing for your financial goals! Sign up for our lectures on goal-based portfolio management and join our exclusive Facebook Community. The 1st lecture is free!
Want to check if the market is overvalued or undervalued? Use our market valuation tool (will work with any index!) or you buy the new Tactical Buy/Sell timing tool!
About the Author Pattabiraman editor freefincalM. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman has co-authored two print-books, You can be rich too with goal-based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice. He conducts free money management sessions for corporates and associations on the basis of money management. Previous engagements include World Bank, RBI, BHEL, Asian Paints, Cognizant, Madras Atomic Power Station, Honeywell, Tamil Nadu Investors Association. For speaking engagements write to pattu [at] freefincal [dot] com
About freefincal & its content policy Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on developments in mutual funds, stocks, investing, retirement and personal finance. We do so without conflict of interest and bias. Follow us on Google News Freefincal serves more than one million readers a year (2.5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified from credible and knowledgeable sources before publication. Freefincal does not publish any kind of paid articles, promotions or PR, satire or opinions without data. All opinions presented will only be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
Our publications

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingPublished by CNBC TV18, this book is meant to help you ask the right questions, seek the right answers and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now. It is also available in Kindle format.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantThis book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at low cost! Get it or gift it to a young earner

Your Ultimate Guide to Travel

Travel-Training-Kit-Cover-new This is a deep dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step. Get the pdf for Rs 199 (instant download)
Free android apps