For experienced investors, maintaining an excessive number of mutual fund holdings can pose challenges, despite its apparent paradox. Although diversification is typically beneficial, an excessive number of funds can complicate portfolio management and hinder the attainment of investment objectives. Having too many mutual fund holdings can be a problem owing to many reasons, some of which include:
- Managing all your investments and assessing their performance can be a challenging task. This complexity can impede your ability to make well-informed decisions regarding your portfolio.
- Furthermore, having an extensive array of holdings can lead to increased fee exposure. Each mutual fund entails an expense ratio, which represents a percentage of your investment allocated to cover the fund’s operational costs. The more funds you possess, the higher your cumulative expense ratio becomes.
- Also, it can complicate the process of rebalancing your portfolio. As your asset allocation evolves over time, ensuring that it aligns with your risk tolerance and investment objectives necessitates periodic adjustments. This task can be more intricate when dealing with a substantial number of holdings.
Consolidating mutual fund portfolio for easy investment
A significant number of investors choose to reserve their portfolio management efforts for the Diwali season. During this time, they take the opportunity to streamline and consolidate their mutual fund portfolios.
There is an ardent need to cleanse up your portfolio. Trimming down your extensive mutual fund portfolio from a challenging 30 or 40 schemes to a more manageable 10 or 12 can be a daunting undertaking. You have two options: you can either dedicate time to reassess your financial objectives and adjust your investment holdings accordingly, or you can consult a financial advisor for expert guidance on essential corrective actions.
Categorizing your investments: All mutual fund houses are allowed to offer up to 36 different categories of schemes to investors. Then there are special kinds of funds that are theme-based, thus, explaining the launch of sectoral funds by certain asset management companies (AMCs) in the country. There is no thumb rule to create an ideal mutual fund portfolio though experts suggest that investors must not opt for more than six to seven fund categories. If you are not sure about where to start, it would do a lot of good to ignore your current portfolio and then decide on an apt asset allocation in sync with your financial goals.
Constructing your equity exposure can be as straightforward as investing in just a couple of well-chosen flexicap funds. These funds offer the versatility to invest across various market capitalizations, delivering diversification across large, mid, and small-cap stocks. This approach has the potential to yield higher returns when compared to relying solely on a single-cap fund. Nevertheless, it’s important to note that it also amplifies the fund’s risk profile.
Customizing your mix of large, mid, and small-cap funds empowers you to take charge of your portfolio’s composition. This approach allows you to fine-tune your exposure to specific market segments that you believe possess greater growth potential. However, this method necessitates a deeper level of research and active management to uphold your desired asset allocation.
Given the growing sophistication of passive index funds and their proven ability to replicate market returns at a reduced expense, it is wise to consider a passive strategy for your exposure to large and mid-cap investments. Passive index funds provide extensive diversification, cost-efficient fees, and a strong likelihood of closely tracking market performance.
Ensuring risk mitigation and maximizing overall returns in your investment portfolio necessitates diversifying across various asset classes. Apart from the conventional equity and debt investments, allocating a segment of your portfolio to gold and US-focused funds can bolster stability and augment growth prospects.
This is because gold has traditionally been regarded as a secure asset, maintaining its worth when economic instability prevails. Furthermore, it provides diversification advantages since its price trends often move in the opposite direction to those of stocks and bonds. Allocating five to 10 per cent of your portfolio to gold can function as a safeguard during market declines. For exposure to gold, contemplate options like Sovereign Gold Bonds (SGBs) or gold ETFs/FoFs.
Allocating your investments to US-centric funds grants you access to the globe’s most extensive and highly developed economy. Over the years, the US stock market has consistently surpassed various other markets, presenting appealing prospects for growth. A portfolio allocation of up to 10 per cent in US-centric assets can complement your domestic equity investments. You might want to contemplate investments in Nasdaq or S&P 500 index funds.
Deciding according to performance: Now that you have decided which category of funds you wish to keep, you may now again evaluate your decision based on mutual fund performance. As you go through this evaluation, there’s no need for concern if you don’t currently hold the highest-ranked funds in every category. It’s important not to hastily dismiss funds that don’t occupy the top positions, as long as they have consistently met your performance expectations.
Emphasizing consistent, enduring performance is essential for a successful mutual fund investment strategy. Although it may be alluring to pursue funds that have recently posted impressive returns, this approach carries risks and may not be sustainable. Instead, give precedence to funds that have consistently provided above-average performance compared to both their category peers and their benchmark over a prolonged timeframe.
Understand that past performance does not assure future outcomes. The performance of mutual funds can exhibit considerable variability over time, and previous returns do not necessarily predict future performance. Short-term returns can be significantly affected by transient market conditions, which can obscure an accurate assessment of a fund’s genuine potential. The tendency to follow the crowd can result in unwise investment choices. Pursuing recent top-performing funds can give rise to a herd mentality, where investors blindly allocate capital to funds with impressive recent returns without taking into account their risk profiles or underlying investment approaches.
Do not stick to one mutual fund house only: Not all asset management companies continue to show good performance infinitely. Highs and lows depend on market conditions, management decisions, and other factors.
Although it’s natural to be attracted to mutual funds managed by an AMC with a track record of consistently strong performance, overreliance on a single AMC can introduce avoidable risks to your portfolio. There are several reasons why having multiple schemes from the same AMC might not be an effective risk management strategy.
To begin with, there’s the issue of concentration. Allocating a substantial portion of your investments to funds within the same AMC can result in concentration risk. This implies that a significant part of your portfolio is tied to a single entity, which can be especially precarious if the AMC encounters financial challenges or regulatory problems.
Moreover, diversification plays a pivotal role in risk management and overall return enhancement. Investing in funds offered by various AMCs introduces your portfolio to a broader spectrum of investment strategies, sectors, and management approaches. This, in turn, lessens the impact of any one fund’s underperformance.
Fund managers or Chief Investment Officers (CIOs) can depart from an AMC for a variety of reasons, and their exit can have a substantial impact on the performance of the funds under their management. Overreliance on a single AMC heightens the vulnerability to the effects of such managerial transitions. As time progresses, investment styles and methodologies can fall out of favour, in line with the shifting market conditions and evolving investor preferences. An AMC that has excelled with a specific style may encounter challenges in adapting to changing market dynamics, which can potentially influence the performance of its funds.
Even if you diversify across different fund categories within the same AMC, there may still exist underlying correlations between their holdings or investment strategies. This could constrain the genuine diversification advantages of investing in multiple funds from the same AMC.
Rather than consolidating your investments within a single fund house, contemplate diversifying your portfolio across various AMCs. This strategy can lessen the risk of concentration and augment diversification. By doing so, you can reduce the potential negative influence of underperformance by any one AMC and potentially boost your overall portfolio returns.
Do not ignore tax implications: It’s essential to weigh the tax consequences carefully before implementing substantial alterations to your investment portfolio. Undertaking extensive decluttering efforts in your portfolio will often involve selling a significant portion of your investments, resulting in the payment of capital gains tax to the tax authorities. While some level of taxation is inevitable, you must take care to not sell a major chunk of your investments in one go.
When liquidating mutual fund units, it’s advisable to give preference to those that you’ve held for more than one year, as they qualify for lower long-term capital gains (LTCG) tax rates compared to short-term capital gains (STCG). Currently, equity mutual funds enjoy an exemption on LTCG up to ₹1 lakh per financial year, whereas STCG is subject to a 15 per cent tax rate. In the case of debt mutual funds, LTCG is taxed at 10 per cent, while STCG is taxed according to the applicable income tax slab rate.
Tax loss harvesting entails selling a portion of your mutual fund units that have experienced losses to counterbalance capital gains earned from other investments. This practice can effectively lower your total tax obligation. Nonetheless, it’s important to make certain that the decision to sell loss-making units is primarily based on investment reasons and not solely on tax advantages.
When making choices about which mutual fund units to divest, it is usually a more tax-efficient approach to consider selling units that you acquired more recently. This strategy has the potential to reduce your capital gains tax liability, primarily because STCG is subject to a higher tax rate compared to LTCG. Additionally, the set-off provisions in the Income Tax regulations permit you to offset short-term capital gains against both short-term and long-term capital losses in any given financial year, whereas long-term capital gains can only be offset against long-term losses.
Before undertaking the consolidation of your mutual fund portfolio, you might consider trimming your positions in underperforming stocks or funds that you’ve been holding onto. This step can help reduce your capital gains tax liability by offsetting these losses against any gains.
Mutual fund consolidation is essential, and there’s no better time to streamline your fund portfolio than during the festive Diwali season. Just as you declutter your home and remove unnecessary items, it’s important to clean up your mutual fund portfolio by shedding non-performing and surplus fund investments.
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Updated: 11 Nov 2023, 02:06 PM IST