How to Diversify Your Portfolio by Investing in Mutual Funds?

Investment diversification is essential for any investor looking to minimize risk and maximize returns. One great option to diversify your portfolio is by investing in mutual funds. With the convenience of online investing apps, it’s now easier than ever to access a wide range of mutual funds and manage your investments from the comfort of your own home.

Mutual funds pool money from investors and invest in various financial assets such as stocks, indexes, bonds, and more. It yields higher returns compared to fixed-income instruments and balances the risk and returns with its diversification properties. While this is beneficial, for those new to mutual funds or investing in general, the process can be intimidating. 

If you are sailing in the same boat, do not worry. This article will simplify the principles of investment diversification and how mutual funds can play a crucial role in diversifying your portfolio. So, let’s get started.Β 

What is diversification in investment?Β 

Diversification in investment refers to the practice of spreading out your investment portfolio across a variety of assets and securities. Diversification reduces the concentration risk that arises by investing in a single security or asset class.

There are many ways to achieve diversification. Here are 3 most common ways to do this:

  • Investing in different types of asset classes (such as stocks, bonds, and commodities)
  • Investing in multiple industries or sectors
  • Spreading investments across geographical regionsΒ 

Diversifying your portfolio can lower your investment risk and can boost your returns on investment.

Now that the basic concept is clear, let us see how to achieve the same via mutual fund investments.Β 

How to Diversify Your Mutual Fund Portfolio?Β 

A diversified mutual fund portfolio invests in a variety of assets across sectors, industries, and more. It often comprises equities, fixed-income, and alternative investments and may be actively or passively managed to meet investment goals. Here is how to undertake that for your investment portfolio.

1. Invest in Different Asset Classes

Mutual fund portfolio diversification relies heavily on investing across many asset types. Your portfolio is significantly subject to stock fluctuations if you just invest in stock mutual funds such as large or small-cap funds 

However, by also investing in a bond or real estate funds, you can potentially offset losses in the stock market and achieve more balanced returns. An example of this type of fund is a hybrid fund that invests in both equity and debt securities. 

You can lower your exposure to risk and perhaps boost your long-term profits by investing in a variety of asset classes.Β 

2. Consider Different Investment Styles

Investment styles are how mutual fund managers choose stocks and bonds for portfolios. Each investing approach has its own risks and returns. By investing in funds with different investment styles, you can balance your portfolio and potentially benefit from different market cycles. 

Some common investment styles include: 

  • Growth: Investing in companies with high growth potential, often in rapidly growing industries such as technology.
  • Value: Investing in companies that are undervalued by the market but have strong fundamentals.
  • Blended: Taking a balanced approach, investing in both growth and value stocks.
  • Sector-specific: Investing in companies within a specific industry or sector, such as healthcare or technology.Β 

Remember to consider your financial goals, risk tolerance, and time horizon when choosing mutual funds.Β 

3. Invest in Funds with Different Market Capitalizations

Investing in funds with varied market capitalisations may diversify your mutual fund portfolio. A company’s market capitalisation is its outstanding shares times its price per share. 

Mutual funds are categorized by company size. They are large-cap, mid-cap, and small-cap. 

  • Large-cap corporations are well-established and have market caps exceeding INR 7,000 crore to INR 20,000 crore. These companies may offer stability and dividends but may not have as much growth potential as smaller companies.
  • Mid-cap companies are worth between INR 500 crore and INR 7,000 crore. These companies may have more growth potential than large-cap companies but may also be more volatile.
  • Small-cap companies have a market capitalization of equal to or less than INR 500 crore. These companies may offer the most growth potential but also come with higher risks.

By investing in mutual funds that focus on diverse market capitalisations, you might possibly gain from varied market circumstances and lower your risk. 

For instance, large-cap corporations may do well during economic downturns and small-cap companies during economic expansion.Β 

4. Include International and Emerging Markets

Mutual funds focusing on foreign or developing markets are beneficial to diversify your portfolio. 

International mutual funds invest in companies based outside of an investor’s home country, providing exposure to different economies, industries, and currencies. These funds help diversify a portfolio and decrease risk since various economies have different market cycles. 

Emerging market mutual funds invest in emerging country firms, which may yield better profits but also higher risk. Emerging markets have distinct economic and market cycles from established countries, making them good portfolio diversifiers. 

However, investing in foreign or developing markets involves currency swings, political uncertainty, and differing regulatory frameworks. It’s important to research before investing in it.Β 

5. Regular Rebalancing

Rebalancing is the act of occasionally altering your portfolio’s asset weightings to keep your desired asset allocation. Over time, the value of your portfolio’s assets may vary, skewing your asset allocation and increasing risk or lower returns. 

For example, You have started with a portfolio of 50% stocks and 50% bonds. But market performance increased the stock percentage to 60%, you may need to rebalance by selling some stocks and purchasing more bonds to return to your ideal 50/50 allocation. 

Maintaining a diverse portfolio and meeting your financial goals requires annual portfolio rebalancing. Online investment tools let you track and alter your portfolio as per your preferences.Β 

The Bottom LineΒ 

Diversifying your mutual fund portfolio is essential for reducing investment risk and potentially increasing profits. You can spread your risk and capitalize on varied market circumstances by investing in multiple asset classes, investment styles, market capitalisations, and overseas markets.

With the rise of online investing apps, it’s easier than ever to access various mutual funds. You can also consider a mutual fund course online by to gain a better understanding of this space.Β 

Deevanshu Kumawat

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