Lowering the Amount of Investments in Your Portfolio: A Guide
In the world of investing, having a well-diversified portfolio is key to achieving optimal returns. However, finding the right balance between diversification and complexity can be a challenge. According to investment experts, an ideal number of mutual funds for an investor's portfolio is around three well-chosen funds.
This approach, often called a "three-fund portfolio," consists of a total U.S. stock market index fund, a total international stock market index fund, and a total U.S. bond market index fund. This simple structure provides broad diversification across major asset classes and global markets while being easy to manage and rebalance.
A three-fund portfolio is widely regarded for its cost efficiency, simplicity, and solid diversification that usually outperforms the majority of more complex individual stock and bond portfolios. It avoids excessive fees and the risks associated with overlapping holdings in multiple mutual funds that can reduce overall diversification and returns.
Some investors may choose to supplement this with additional asset class funds like REITs or small-value stocks for potential extra returns, but these often add complexity and higher costs, with limited evidence of superior performance for most investors.
It's important to note that asset allocation within these funds should be adjusted based on the investor’s age, risk tolerance, and goals. For example, a younger investor might hold a higher equity ratio, while those closer to retirement might have more bonds to reduce volatility.
Managing a portfolio with many funds can also be difficult due to tracking performance, exiting underperforming funds, and managing taxes. Having more than 30-40 mutual funds in a portfolio can lead to dilution of returns.
To help you manage your portfolio effectively, there is a free portfolio health check tool available on our platform that can help identify what's wrong with your portfolio and help you exit undesirable funds. Portfolio overlap, where schemes in your portfolio have a large percentage of overlapping holdings, can be simplified by exiting the duplicates.
When it comes to sectoral and thematic funds, they are not suitable for an average investor due to limited diversification and high volatility. Flexi-cap funds, which can invest in companies of all sizes and in any proportion, are often the better choice for most investors who want to build wealth with equity funds.
In summary, owning about three well-chosen mutual funds usually balances optimal diversification, low complexity, and cost-effectiveness, which together support better risk-adjusted returns. Your portfolio should be aligned with your financial goals, which could be short, medium, or long-term in nature. Analyse your goals and desired asset allocation and then build a model portfolio. Remove the funds that won't help you with your goals.
Remember, investing is a long-term game, and consistency is key. Regularly reviewing your portfolio and making necessary adjustments can help you stay on track towards your financial goals.
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- In addition to the three-fund portfolio, some investors might include hybrid funds, such as equity funds and debt funds, to diversify further and potentially gain extra returns, but these funds may add complexity and higher costs.
- A well-structured portfolio might also consist of fixed deposits, as they offer low risk and a fixed rate of return, but they may not provide the same level of diversification and potential for growth as mutual funds.
- Personal-finance experts often suggest that managing a portfolio with many mutual funds can be difficult due to various reasons, such as tracking performance, exiting underperforming funds, and managing taxes, which can lead to dilution of returns.
- To maintain a simple and cost-effective portfolio, it's essential to choose the right type of mutual funds, such as mutual funds that track major asset classes and global markets, like equity funds, hybrid funds, and debt funds, and adjust the asset allocation based on your age, risk tolerance, and financial goals.
