Importance of a Well-Diversified Portfolio

Diversification is one of the most effective techniques to diversify the risk involved in investing your funds. Several types of financial instruments exist with the equity ones offering good returns but are risky while the debt-related ones are secure and less risky but offer lesser returns.

To achieve both stability and good returns you have to go for a mix of the various types of instruments and have a well-diversified portfolio. “Don’t put your eggs in one basket,” sums up the meaning and the importance of diversification. You can either chose to allocate your funds for investment in different asset categories or invest in mutual funds which invest in a variety of instruments.

Diversification with Mutual Funds

Since diversification means owning a variety of assets that perform differently and have different risk profiles, you will need to have an idea about their working. But what if you do not have the time and the resources to carry out the necessary research for investing in varied assets? You can go for investment in mutual funds which work by pooling the funds of various investors and investing them in different categories of investments.

Mutual funds in India serve the dual purpose of diversifying the risk associated with investment and offering you the opportunity to take exposure in a variety of instruments including the ones which you may not have chosen normally. You can choose to invest in equity mutual funds by opting for a systematic investment plan or SIP wherein a fixed amount is invested every week, month, quarter or bi-annually. This is a disciplined approach to investing. However, if you have surplus funds available that you wish to invest in immediately. Go for the lump sum option.

Types of Mutual Funds

Mutual funds can be of different types having different investment goals and different types of portfolios:

• Equity Mutual Funds: These funds mainly invest in equities and equity-related instruments with some portion invested in debt and other instruments. Amongst equity classes, the funds may invest in large-cap stocks, mid-caps, small-caps or a mixture of all the types. Then some funds may invest in the stocks of a specific industry. These funds generally generate good returns over the long term.
• Debt Mutual Funds: These funds invest in a variety of debt instruments such as corporate bonds, money market instruments, and treasury bills. More stable than equity funds, this category of mutual funds is more liquid and tax-efficient when held for over three years.
• Hybrid Mutual Funds: As the name suggests, these funds invest in both equity and debt in a pre-decided composition to diversify the risk associated with stocks.

The decision to invest in which and how many mutual funds in India will depend on the funds available with you, your investment goals, and the risk tolerance capacity. You can choose to either invest in a single mutual fund investing in diversified instruments or go for several schemes with each one investing in a different class or category of financial instruments. But do not go overboard and invest in only two or three funds so that you can monitor and track their performance effectively.