Why are there too many mutual funds (MFs) in an investors portfolio? I am seeing that even wealth managers are recommending many clients so many MFs in their portfolios. 20-30 MFs is something which I am seeing in investors portfolio. What could be the cause of that? There could be multiple reasons to it. Firstly, I think overall its the problem of chasing past returns. Secondly, when there is a small underperformance in a fund, immediately investors pick the next best performing fund.
So why is it a problem to have too many MFs in a portfolio? What is wrong with it? Too many mutual funds in your portfolio results in a distribution of stocks across the index. Sorry, essentially we just created ourself a costly index fund 🙁 There is strong correlation between holdings of so many MFs and there is almost no benefit of diversification as well.
So should we ignore underperformance by a fund? Of course not, but the time period of underperformance and the reason for underperformance is important. If sufficient time has been given (my thumbrule is 5-6 quarters), then its time to move out of the fund.
Remember the fundamental principle of why we invested in a mutual fund. Its because we lack expertise to pick the right stocks, so we outsourced the stock selection to the fund manager. Now we are spending our time out there selecting best MFs?
So what should we chase, if there is a problem of chasing past returns. There are a bunch of things we can chase:
- Good themes fitting our needs
- Good fund manager
- You like the portfolio held by the fund
- Good diversification provided by the fund to your overall portfolio
So what should we do if we have too many funds in our portfolio. This is going to be a separate blog on what we can do to mitigate this too many MF in the portfolio problem. If you have come this far in this blog, you might as well read my view on how many MF one should hold 🙂
