Why Diversification Matters in Mutual Funds

When you invest in a mutual fund, your money is pooled with investments from other investors. This combined capital is used to build a portfolio spread across many securities.

Creating this level of diversification on your own would typically require significant capital. Mutual funds make it possible to access diversified portfolios even with investments starting from ₹100.

Exposure Across Companies, Sectors, and Market Segments

Portfolio diversification in mutual funds isn't just about holding many stocks. It's about spreading across:

• Companies: Large-cap, mid-cap, small-cap

• Sectors: IT, banking, pharma, FMCG, energy etc.

• Asset classes: Depending on the scheme, funds may invest across equity, debt, commodities, or overseas assets.

Sector diversification helps manage fluctuations, as various sectors may perform differently at different points in the economic cycle. This can support a more balanced portfolio experience.

Role of Fund Managers in Maintaining Diversification

Fund managers keep portfolios diversified by monitoring allocations and adjust holdings as market conditions shift. SEBI mandates limits on how much a fund can invest in a single stock to prevent concentration risk.

Investors often think more funds equals more safety. So they buy 8 to 10 mutual funds across categories, thinking they're hedging risk.

The problem is over diversification in mutual funds creates overlapping portfolios and duplicated holdings. If three of your large-cap equity funds all hold the same top 10 stocks, you're not diversified.

How many funds are enough?
For most investors, 3 to 5 well chosen funds across different categories are sufficient. More than that, and you're likely duplicating exposure.

SIPs often get confused with diversification. Let's clear that up.

SIPs as a Discipline Tool, Not a Diversification Tool

SIP doesn't diversify your portfolio. It's a method of investing - you put in a fixed amount every month. Whether you're investing in one fund or five, the SIP is just the delivery mechanism.

Reducing Market Timing Risk Through Regular Investing

What SIPs do is remove the need to time the market. You invest every month regardless of whether markets are high or low. Over time, this averages out your purchase cost - you buy more units when prices drop, fewer when they rise.

How SIPs Complement Diversified Mutual Fund Portfolios

The combination of diversification and systematic investing reduces both concentration risk and timing risk.