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No additional diversification is provided by investing in more funds beyond a point. Tracking is important.
Flying blind is a commonly used phrase for doing something without having any idea of where one is going. Of course, in case of actual flying, it’s okay because aircraft have instruments that enable pilots to fly when nothing is visible outside. Investors don’t have access to such instruments. Or perhaps they do, but more on that later. I find that because my general interaction is mostly with people who have at least some awareness of savings and investing, interactions with others sometimes come as a shock.
Recently, an acquaintance who is in his early 50s years came to meet me. Like many people, his career, which is in the hospitality industry, has taken a negative turn and he is earning a lot less than he used to. He wants to retire at some point not too far into the future. Most years in the past, he has saved money by making at least the tax-saving investments. Generally, this has been in PPF. He has also made some mutual fund investments, always driven by some agent or the other whom he came across in his profession. In recent years, he had also made a beginning with the National Pension System (NPS).
Overall, apart from his PPF deposits and NPS, he has investments in about 70 funds. This is a shocking number of funds to have invested in. Unfortunately, it’s not all that uncommon. People whose fund investments have been driven by salespeople for many years commonly have investments in a lot of funds. In the years past, salespeople got a high commission when the saver put his money into a fund, but much lower later. The incentive was to keep talking the saver into investing in newer and newer funds under the garb of diversification.
Investors think that the way to achieve diversification is to invest in lots of funds. However, the truth is that no additional diversification is provided by investing in more funds beyond a point. Mutual funds are not an investment by themselves. They are a way of holding the underlying investments which, for equity funds, stock. The reason why too much diversification is pointless is that the stocks held by similar funds tend to be a similar set. Beyond a small number like five or six, when you add more funds, you are generally adding more stocks that are similar or identical to what you already have.
You are also flying blind. My friend had no sane way of monitoring 70 funds or even having a clear idea of their returns and weights in his investment portfolios. Upon my exhortations, he entered all his investments into the ‘My Investments’ tracking system. The mutual funds, he was just able to import at one shot from the combined account statement that can be obtained from the CAMS website. Entering NPS and PPF was also simple. Now, he was no longer flying blind. On a consolidated basis, he had about Rs 75 lakh in all, out of which about half was in PPF, about Rs 3 lakh in NPS and the rest in that huge pile of 70 funds. However, the toolset on Value Research Online also helped him make sense of all these things. Not only did he get a clear idea of which of these to sell off, but also the tax liability he would face on selling.
Now, Rs 75 lakh is not much of a retirement kitty for a middle-class family nowadays. My friend will make do because he is lucky to have some inherited property. However, the fact is that if he had stopped flying a decade ago, he would have been in a much, much better position today. With the tools and information available today (mostly for free), ignorance of one’s own finances has no excuse.
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