Here is a question to ponder: How many mutual funds should you hold in your investment portfolio? This question assumes importance because of the large number of products available in the marketplace. In this article, we discuss why it is better for you to hold 5-6 funds. We also discuss how you should choose such funds to build your investment portfolio.

Less is more

Given that you keep long working hours, it would be a shame if you spend significant part of your non-working hours in researching and monitoring your investments. You should, therefore, have a small portfolio containing 5-6 mutual funds, whether you buy active or passive products. Why?

For one, most active mutual funds invest in the same universe of stocks. Whether you buy funds benchmarked to the Nifty Index or to the BSE 200, your investments are primarily in stocks such as ITC, SBI, L&T and Reliance Industries. Buying several active funds does not necessarily help you take exposure to more stocks. It primarily gives you higher exposure to the same universe of stocks. So, why buy 10-15 active funds? The case is more powerful for index funds. All index funds on the same index have the same portfolio. So, why buy more than one index fund?

For another, buying fewer funds gives you the flexibility to reduce your equity investments. How? Suppose you have an equity portfolio worth Rs 50 lakh invested equally in five equity funds. Unrealised gains of, say, 10 per cent on the portfolio amount to significant cash flows, meaningful to take profits and reduce your equity investment, if required. But if you instead have 15-20 funds, your cash flows from selling each investment may be insignificant. And that could prompt you to hold your investments for longer time… and risk losing your unrealised gains. So, how should you create a least-efforts portfolio?

You should follow a core-satellite framework to create a least-efforts portfolio. The core portfolio will consist of index funds and the satellite portfolio, sector and thematic funds. Why? A significant proportion of the portfolio returns is due to market factors. And index funds provide you low-cost exposure to such factors.

Least-effort portfolio

How should you buy index funds? While all index funds on the same index carry the same portfolio, their returns are different for two reasons. One, funds hold varying cash component to meet unit-holders’ redemption requests. And two, such funds charge different fees and expenses. You should, hence, choose a fund that consistently has the lowest tracking error, a measure that captures the deviation from the index returns. This metric is available on a fund’s fact sheet. You can buy an index fund on the S&P CNX 500 Index. Alternatively, you can buy one Nifty Index Fund and one mid-cap index fund or ETF.

Your satellite portfolio is created to capture short-term profit opportunities in the market. You can buy ETFs if you want to set up a systematic buying and selling process to capture the short-term movements on the Nifty Index or on the sector indices such as the Bank Nifty. Alternatively, you can buy sector and thematic index funds, if available, or active funds. The objective will be to buy sectors and themes that you believe will do better than the broad market. You should have not more than four funds in your satellite portfolio.

It is not enough if you create a least-efforts easy-to-manage portfolio using 5-6 funds. It is equally important that you resist the temptation to buy new funds and unintentionally increase your portfolio size. Alternatively, you can replace one of your existing investments with the new fund. Your portfolio should cover important segments of the market and yet not require you to spend significant non-working hours in monitoring the investments.

(The author is the founder of Navera Consulting, a firm that offers wealth-mapping and investorlearning solutions. Feedback can be sent to >knowledge@thehindu.co.in )

Related Topics
comment COMMENT NOW