World Sep 04, 2015 08:57 AM EDT

Over diversification could dent returns on your funds

By Staff Writer

Don't put all eggs in one basket - this is basic investment principle in portfolio diversification. But keeping eggs in so many baskets will also not give the desired results, alert analysts.

Each portfolio of investment in a particular fund has certain diversification. A balancing act in equities, bonds, currency, etc. Analysts advise investors to do some homework to mitigate the risk associated with funds that bear more correlation to one another.

If equities tumble, bonds will go up and vice versa. If one invests in too many funds then this will make more complicated. Investing in too many funds will take off the advantage of cushioning from ripple effect in the financial markets.

Investing in too many funds is like a habit of collecting stamps or coins or rare antiques. This habit doesn't work well in money investing.

Parking the funds in too many funds and stocks involve several undesired things. Some of them include high investment cost, add layers to required due diligence, below average risk-adjusted return, etc.

Many mutual funds have several types of portfolios. Investing in fundamentally similar holding and strategies will result in higher cost and increase the required investment due diligence. It'll also reduce the rate of diversification.

When investing in multi-manager products, investor should analyze the diversification benefits against lack of customization, high costs and layers of diluted due diligence.

Investing in too many numbers of stocks also can lead to complicated tax situation and high cost as well. A well accepted rule of thumb is that it's ideal to invest in 20-30 stocks from different industry sectors. In general, there's no specific bench march on how much diversification is ideal. Considering the investment cost, due diligence, correlation of funds/stocks, tax implications, investors need to take decision.

It's better to invest in different funds rather than putting entire money in one asset. If one does so by investing in one fund only, then losses would be huge if the value drops. The idea behind putting investment in different funds is that if one underperforms then another fund will set off these losses as correlation is low.

However, the risk can't be removed in any portfolio regardless of its diversity. At the same time, don't hoard investment blindly hoping that it'll help you tide over the uncertainty in the market. Too much of a good thing can also lead to undesired results. Investing in too many funds, stocks will in fact do more harm to the portfolio than averaging the risk factor.

For instance, if an investor parks his money in 56 different mutual funds (MFs). Does it give a balanced portfolio? No, investing in too many will take of the balancing act of portfolio.

It's always better to take an advice from equity analysts before investing in funds. The reason is simple, if correlation among the funds is high then chances of eroding profits in an unforeseen market sell-off will also be high.

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