There are two most popular methods available for investing in stock market for an average investor, i.e., directly investing into the market and investing through mutual funds. There are a number of differences between investing directly in stocks and via mutual funds.
The need for Mutual Fund was realized in the wake of increasing volatility in the stock market. Given its unpredictable nature, the watchdogs of the market have introduced Mutual Funds to protect the investors’ interest and make the investment process in stocks more reliable.
Mutual funds are headed by a fund manager whose core area of responsibility is to monitor the proper management of funds. The fund manager would ensure that an investor’s fund remains healthy and in a step wise manner choose to add or omit stocks from diversified industries and sectors.
Investing in mutual funds is always a safer option owing to its great level of investigation rather than directly investing in stocks. The fund manager has a team of analysts who aid in ensuring that he/she has a healthy fund comprising mixture of healthy stocks from different industries. The fund manager on the investor’s behalf takes the decisions, thus the investors do not have to do the researching and thinking which he/she would surely have to do if directly investing in stocks.
Now, the question is how many mutual funds one should have. Well, it depends on an individual need and situation. Although, an investor can always arrive at a number or a range, which should be ideal for a large chunk of mutual funds investors. Many a times investors invest in a large number of mutual funds, which do not add any additional value to their portfolio.
Did you ever ask yourself what is your investment style? Is your portfolio of mutual funds cluttered or well framed? Do you own some mutual funds so long that you have forgotten why you bought them? Adding new mutual funds to your portfolio is far easier than reorganizing your fund portfolio and discarding inappropriate, redundant, or simply poor-performing mutual funds. If you have more than eight mutual funds, then its time to decide which one you have to close down.
The ideal thing is to invest in more than one Mutual Fund but certainly not as much as eight. Now, why invest in more than one mutual fund is because having more than one Mutual fund in portfolio reduces the risk. There is this concept of standard deviation; it is nothing but risk and return potential from mutual funds point of view. Therefore, a single mutual fund has the highest standard deviation and the risk and return can be very high. Adding more funds will help in reducing the standard deviation of the portfolio.
Once you own four funds, the effect of adding another fund diminishes. After investing in seven funds, things mostly levels out and after ten funds, a portfolio’s standard deviation stays nearly the same no matter how many funds you add. In short, once you own between seven to ten funds, there may be no need for more.
The bottom line is the more funds you own, the more likely you are to own at least a couple that do the same thing. That could be a drag on your returns because if you have multiple funds doing the same thing, one is likely to be better than the others. What you should be doing at such incident is focus on the superior fund and you will get better returns.
Disclaimer:
1. Views, as are mentioned in the article, are personal views of Author and nothing to link with Co., its Director and Employees.
2. All investments are subject to market risk and you need to consult your financial advisor/consultant before investment