How to manage all your extra stocks and MFs
We have a general tendency to get tempted whenever there is an initial public offering (IPO) for stocks or a new fund offering (NFO) for mutual funds. And, this is becoming more lucrative nowadays as each offering has a unique selling proposition (USP).
The offers are irresistible so much so that one ends up collecting plethora of stocks and mutual funds only to realise that managing such a portfolio is a cumbersome task.
Managing 5-6 investments is easy. But when the number of investments increases significantly, the problem starts creeping in. When this problem aggravates further, it leads to panic selling and the basic idea behind investing is lost.
In a worst-case scenario, you may end up making huge losses and may never recover. So what's the way out? How many investment products (stocks or funds) are enough? Let's look at this subject in greater details in the following sections.
The author is co-founder and director of Bangalore-based Perfios Software Solutions Private Limited. www.perfios.com is a personal finance software solution that provides a 360-degree view of your personal finance, with very little manual intervention.
Photographs: Rediff Archives
How many stocks to own?
We invest in select stocks to play the high-risk and high-reward game and we invest in numerous stocks to mitigate risk or to avoid volatility. The basic idea for many people is to diversify investments. But, over-diversification is also a problem leading to unmanageable portfolio. So, how many stocks will make a good diversified portfolio?
Although, there is no magic number behind this, it is said that 15-20 stocks make a good number. Beyond this number, the returns tend to average out and volatility remains constant.
However, this assumption also depends on one's stock selection criterion. If all 15 stocks belong to same sector, say technology sector, the portfolio is not completely diversified. When the technology sector collapses, portfolio will feel the heat too.
This magic number of 15 is applicable only if your investment contains stocks of various sectors.
However, these numbers must not mislead one. The idea should be to invest your savings to generate higher returns in future. If one is an avid and hardcore market follower, it is easy to play it in your own way and manage any number of stocks with ease.On the contrary, cautious investors who don't follow market on a regular basis should stick to a maximum of 15 stocks. Once this number is reached, one must think of rebalancing existing portfolio -- selling dud stocks or over-gained stocks and re-investing in other potential gainers.
How many mutual funds to own?
Mutual funds, by nature, are diversified. So, owning just one mutual fund enough to achieve diversification? This is very tricky. Isn't it? But let's understand the logic first.
Each mutual fund has its own investment objective -- to invest in either large-cap, mid or small-cap, bonds or in a certain combination of stocks and bonds. If one holds various kinds of mutual funds it can be considered as a diversified portfolio.
But again what's the magical number in case of mutual funds to achieve proper diversification?
Historically, it is observed that standard deviation (the measure of a funds volatility) of one fund is always greater than that of portfolio of more than one fund. Hence, with every addition of fund, the volatility falls.
But after certain number of fund additions, the volatility remains unchanged. As per our research and experience, the magical number for mutual fund diversification is 6 to 7 funds. But again, the assumption is to have various types of funds instead of similar type of funds in the kitty.Having 6 mid-cap funds or 6 large-cap funds in isolation, does not make your kitty diversified.
The bottom line
This brings us to another important point of fund duplication. If one already owns two large-cap funds and there is a NFO for a new large-cap fund, it is a good idea to first check the existing large-cap holding before scouting for the new one. If any of the existing funds is not performing well, the ideal way would be to sell that dud fund and then go for the new fund offering.
Otherwise, if all existing funds are in good shape, then ignoring the NFO is advisable.
The bottom line
Whatever number of stocks or mutual funds you own, the bottom line should be to comfortably manage them. These magical numbers should be used as a guide or an alarm to re-think on the existing investments. We hope this will help you in making better investment decisions.Keep evaluating your existing investments and be prudent while entering into new ventures.