How many funds do you have in your portfolio?
2, 4, 10, 20 or even more? Is this a problem?
What’s the problem with having too many funds in my portfolio?
With the fine MF software available, analyzing or analyzing a portfolio with too many funds is not that complicated. A bigger problem, however, is decision making.
A portfolio with many funds is difficult to manage. It makes decision making difficult. It also causes decision paralysis. Unless a fund’s poor performance is materially affecting your portfolio, you are unlikely to touch that fund. You will forever be stuck with such bland investments.
By the way, “Too Many” is subjective. For some there are even 3-4 too many. No number is too high for others. I’m good at holding funds as long as each fund has a purpose in the portfolio and a meaningful allocation. Well, let’s not get caught up in it.
The real question is what to do when THEY feeling Do you have too many funds in your portfolio? How do you reduce the number of funds? Which funds should be left? Which one should I keep?
Before we get there, however, let’s first see why we have this problem in the first place.
Why do we have many funds in our portfolio?
There are some investors who simply cannot imagine being in a poorly performing fund or NOT in a best performing fund. You’re just too concerned about “What if my fund doesn’t do well?” Even if they have to invest Rs 1 lac in ELSS to save on taxes, they split the amount into 4 ELSS funds. Such investors are difficult to convince.
However, most investors do NOT start out with many funds. The number of funds usually increases over time. You start with Fund A and Fund B. After a few years you will realize that Fund C and D are the flavor of the season. You stop investing in Funds A and B and start investing in Funds C and D.
While you are forwarding incremental funds to C and D, you continue to keep funds A and B in the portfolio.
And it’s not just about chasing performance. Your thought process could change as well. Today you are optimistic about large-cap funds, or say the pharmaceutical sector. They add some pharmaceutical funds to the portfolio. After a few months, you start to like the outlook in the IT sector or mid-cap stocks. They add some IT and midcap funds to the portfolio. Then bank stocks or small-cap stocks. The number of funds continues to grow.
There is nothing inherently wrong with tailoring your portfolio to suit your prospects. The problem is, most of us don’t have the timing right. You don’t want to move into a sector that has underperformed after getting in. But doesn’t that usually happen? Money chases performance. When a particular sector or fund is doing well, investors direct more money into that sector or fund. Eventually, the mean inversion sets in and performance is usually well below expectations.
From the point of view of the number of funds in the portfolio The problem is that once a fund is in, you don’t throw away it. Regardless of how the fund performs or what you think of the underlying stocks, such funds never find their way out.
first, the indolence.
SecondlyYou don’t want to leave a fund until you’ve at least broken even. You don’t want to post a loss. And if the fund breaks even at some point, it will be fine. And you want to hold out for a while to drive the good performance.
ThirdLeaving the old funds is a decision. And every decision challenges you with “what if”. What if Fund A performs well immediately after exiting the fund? And that could actually happen. And nobody wants to live with regrets. Better still, don’t do anything and leave the funds in your portfolio.
You repeat this cycle a few times. And you have 12-14 funds in your portfolio.
This only applies to equity funds. You also need outside capital in the portfolio.
How can the number of investment funds in the portfolio be reduced?
# 1 Remove any funds that have exposure less than 5% of the portfolio
This is a low hanging fruit. When is a fund less than 5% of the portfolio (talk about stock funds) and you are not even add to the fundyou have to leave such a fund. And do it recklessly.
reason: Since you are not increasing this fund, this investment is likely to get smaller and smaller in the portfolio. If the percentage allocation decreases, the ability of a fund or investment to affect the overall performance of the portfolio decreases sharply.
Even if that small part (allocation) does remarkably well, it wouldn’t move the needle for your portfolio. In other words, the impact on your portfolio doesn’t matter.
Therefore, to keep the portfolio simple, end small (and meaningless) allocations in the portfolio. So if you invested Rs 5,000 in a pharmaceutical fund 3 years ago, it is time to end that investment regardless of its performance.
Before you exit, consider the impact on the exit burden and the impact on capital gains tax.
# 2 Every fund in the portfolio should serve a purpose
4 large cap funds in the portfolio will not add much value to the portfolio. A strong overlap of stocks is to be expected in the portfolios of these funds. It is likely that not all 4 large-cap funds are the best or worst performing funds. With 4 large-cap funds, you achieve mediocre performance. For such a performance, it is better if you invest your money in a simple large-cap index fund. And the low cost, and ultimately the cost, weighs on the performance of your portfolio.
So if you own 5 mid-cap funds or 7 small-cap funds, you need to rethink your portfolio strategy. Investing in 5 midcap funds is not considered diversification. It’s confusion. Avoid holding many similar funds in your portfolio.
Take one or two midcap funds (by any criteria) and consolidate the midcap portfolio into the selected funds.
First decide the portfolio structure. Let’s say 50% large cap, 30% midcap, and 20% small cap (this is not a suggestion). And then Raise money to fill the structure. Not the other way around. Such a structure will make your fund selection more thoughtful and fit for purpose.
OR If you want to make more colorful investments, think about the core and satellite portfolios and decide on the allocation to each portfolio and the sub-allocations within each portfolio. Assume 50% of the core portfolio with the same exposure to national and international large-cap indices. The remaining 50% of the satellite portfolio was built with exposure to midcap funds (25%) and sector / thematic funds (25%).
# 3 Before you wind up your portfolio, you need to dissolve your thoughts
In order to keep your portfolio simple and small, you must first believe in the power of a simple portfolio. Trust me it ain’t easy
There are some investors who only have a few diversified index funds in their portfolio. If you are such an investor, you are happy and satisfied. They ignore noise that is abundant in financial services. They don’t care about the subject, sector or fund that is in vogue today. Don’t be jealous if your roommate has earned 15% in the past 1 years while your fund has only given 10%.
You don’t use energy to choose the best performing theme or fund. This allows you to focus on more important aspects of asset allocation and portfolio rebalancing. More importantly, asset allocation and portfolio realignment are also the aspects that you can control. You do not control how a fund will perform after your investment.
For most private investors like you and me, this is also important from a portfolio performance perspective. We’re usually late for a party. By the time a sector or topic catches our attention, it is usually already on its way.
It’s not that you can only achieve this discipline with passive index funds. You can also do this with actively managed funds. Just that you need to understand that the baton of the best-performing funds is always changing. No actively managed fund (or investment strategy) is always good. There will be periods of underperformance and outperformance. Do you need to give your investments a longer rope?
And this is where things get complex. How do you know if your active fund’s recent underperformance is temporary or if it will last much longer? Nobody knows. You can’t trust AMC or the fund manager’s comment on the underperformance. It’s just post-mortem, unusual prognoses and carefree talking. This is zero and does little to help you make a decision. So you need to have a very objective exit criterion. Let’s say 3 years or 5 years underperformance versus benchmark or anything else.
With such a process, your equity fund portfolio will be simple, precise, and easy to manage.
While I suspect the benefits of reducing mutual funds in my portfolio, my own balance sheet for my portfolio and the portfolios of my investors has been mediocre. And the reason was primarily the developing thought process. Initially, there was a strong reliance on actively managed funds. Now the focus is more on passive investing (both market capitalization based indices and factor based investing). With greater clarity about the portfolio structure and fund selection I wanted, I was able to easily create most of the equity fund portfolios. However, things have been complicated with debt due to the three-year holding period for long-term capital gains and the unique cash flow requirements of investors. The fact that MF redemptions work on a FIFO (first-in-first-out) basis is also a challenge. And I just prefer to work with more debt in the portfolio. Provides me with more flexibility in meeting investor cash flow needs. In progress.