Reasons why over-diversification can go wrong at times

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Investors in mutual funds benefit from portfolio diversification. This guarantees them a consistent stream of returns regardless of the value of individual funds of their portfolio. Knowing that profits will always occur in other segments of the portfolio. This benefit of portfolio diversification will not be available to individuals who trade directly in stock markets. In other words, diversification provides significant benefits and is a substantial feature of mutual fund investing.

However, the rule of diversification may not apply if investors fail to find the proper balance of diversity. Diversification can go wrong at times, and owning too many mutual funds might result in more losses than benefits. This is because investors may end up investing in funds that invest in the same or similar equities or in funds such as value or growth that have a similar investment philosophy and strategy.

Strategy

For example, an investor who owns MF Large Cap Fund, MF Blue Chip Fund, and MF Equity Fund has a total of three schemes in their portfolio. However, all three are in the large-cap category, and each mirrors the other two, resulting in duplication. Such duplications only increase the number of funds but add no diversification value. Thus, the successful strategy is to find a middle ground that maximises returns.

Avoiding fund clutter is one method to strike the perfect chord in diversification. While diversification is critical for any portfolio, buying an excessive number of funds can result in investment mistakes. It is preferable to adopt a more careful planning approach as an investor and understand without losing sight of the bigger plot, i.e., the financial objective stretched over a time period.

Demerits

-A significant disadvantage of excessive diversification is the difficulty of keeping track of all the money on a regular basis. One must review all applicable statements linked to a plethora of finances on a frequent and thorough basis. This may prove to be a nightmarish scenario for the average investor.

-Another concern connected with excessive diversification is the ongoing requirement to monitor the performance of the funds and rebalance the portfolio based on each fund’s performance.

Thus, buying a correct fund with distinct investment styles and strategies may be a prudent idea. Another frequent investment error in diversification is fund duplication. This is because investors may end up selecting funds that invest in identical or very related stocks.

This is not to suggest, however, that diversification is unnecessary. If there is insufficient or no diversification, the dangers lurking for the investor will naturally increase. As a result, investors should ensure that their portfolios are appropriately diversified.

As the investor’s risk profile changes, the percentage allocation shifts from aggressive to conservative. A conservative portfolio would have a lower allocation to equities funds and a higher proportion to debt.

To summarise, diversity protects investors against risk. However, overdoing it or diversifying too much may result in reduced or even negative results. It is preferable to diversify investments across categories, as this effectively ensures an edge for investors, as outperformance in one category can compensate for underperformance in another. Additionally, investors should avoid numerous schemes with the same style that invest in similar category funds.