Owning eight mutual funds is not diversification

A common portfolio looks like this: eight equity mutual funds, picked at different times from different recommendation lists. On paper it looks spread out. Open the holdings, though, and the same twenty large Indian companies show up in most of them. That is one bet held eight times, with eight expense ratios.

Diversification is about what moves together

The aim is to hold things that do not all fall at the same time. Two large-cap funds tend to fall together because they own the same companies. Buying the second one does little for risk, adds paperwork and makes the portfolio harder to judge.

A wider spread comes from assets driven by different forces: equity, debt, physical assets such as property or gold, and cash. Each reacts to different conditions, so a bad year for one is not automatically a bad year for the others.

The concentration many Indian households have

For many Indian households, the biggest concentration sits outside the portfolio. The family home often makes up most of their net worth, usually bought with a loan, in one city and one property market.

That is a reasonable choice, but it is a concentrated position, and it should shape what the rest of your money does. If one property accounts for most of your net worth, avoid taking concentrated bets in your financial portfolio as well.

Employer stock is the other one to watch. If you hold a lot of it, your salary and a good part of your savings depend on the same company, so a bad outcome there hits both at once.

Decide the split before picking funds

How you divide money between equity and debt explains far more of your result than which fund you pick within each. It is also the decision most people spend the least time on.

Two things set the split: when you need the money, and how you behave in a bad year. Money you need within three years should not be in equity, however good the long-run numbers look. Money you will not touch for fifteen years can hold a lot of equity, provided you can leave it alone when it drops 30%. That depends on your temperament more than on the market.

Age-based rules are a fair starting point, but they fall short on their own. A 30-year-old saving for a house down payment due in two years needs a different allocation from a 30-year-old saving for retirement.

When another fund makes sense

Each extra equity fund should add something the others lack, such as a different market capitalisation, geography or style. Three or four funds that differ in these ways cover most of what a retail investor needs. Past that point you are usually paying more to own the market, which an index fund gives you more cheaply.

The mutual fund calculator and the investment calculator show what a given mix could grow to. They cannot tell you whether two funds overlap, so check the holdings yourself before adding one.

Rebalance rarely, and by a rule

Left alone, a portfolio drifts towards whatever has done well. It becomes most aggressive when the risky asset is at its most expensive, which is the opposite of what you want.

Move it back to target once a year, or whenever a holding drifts more than a set margin away. Where you can, do this with new contributions, which avoids tax and transaction costs. Expect it to feel uncomfortable, because rebalancing means putting more money into the part that has disappointed you.

Count EPF, PPF and debt funds together

EPF, PPF and a debt fund are all fixed income. Holding all three gives you one asset class in three wrappers, each with its own tax treatment and lock-in. Add them up when you measure your split. Otherwise you may think your portfolio is balanced when it leans heavily towards debt.

How this affects your Health Score

Diversification is one of the seven pillars in your Financial Health Score. It is scored on how your money is spread. The number of products you hold does not feed into it, because a long list of funds can still be concentrated in one place.