Many investors believe that owning 25 to 30 mutual funds automatically makes their portfolio well diversified, but this approach may actually be counterproductive. According to Certified Financial Planner (CFP) Shweta Shastri, holding multiple funds does not necessarily improve asset allocation. As reported by Upstox, she explains that even a large and complex portfolio may still be poorly structured if most money is exposed to the same asset class. When this happens, portfolios behave in a highly correlated way, where everything moves together, either up or down, which is not true diversification but concentration wearing a disguise. Mint confirms that over-diversification occurs when investors continue adding new mutual funds, stocks, or asset classes in the name of reducing risk, resulting in individuals owning multiple schemes with overlapping or similar portfolios.
A case study of a ₹1.5 crore portfolio with 22 mutual funds illustrates the over-diversification problem. According to Upstox, the portfolio appears diversified across equity, debt, hybrid, gold, and international funds, but closer analysis reveals significant issues. The equity exposure remains concentrated in large and mid-cap funds, with multiple funds holding similar stocks. Debt and liquid funds have relatively small shares compared to equity exposure, meaning the portfolio may still move heavily during market swings. CFP Shastri notes that retail portfolios are often built fragmented, with investments recommended by friends, bought for tax saving, or added after recent performance, which may lack structure and intent when combined. Mint provides specific examples, noting that having 12-15 very good stocks in a portfolio can be reasonable, whereas having 50 or 70 stocks constitutes clear over-diversification in equities.
CFP Shastra recommends a simple five-step approach to correct over-diversification issues. As reported by Mint, the strategy begins with starting with asset allocation, not fund selection, making sure investors decide how much to allocate across asset classes such as equities, debt, gold, mutual funds and international assets based on economic objectives and risk tolerance. The second step involves eliminating overlapping funds, as holding three large-cap mutual funds rarely offers three times the diversification, requiring comparison of portfolios and removal of schemes investing in largely the same stocks. The third step emphasizes giving every fund a clear role, with every fund having a specific objective such as core growth, child education planning, stability, tax savings, or global exposure. The fourth step focuses on consolidating around quality, not quantity, with a well-thought-out portfolio accomplishing objectives with just five to eight diligently selected funds, making monitoring easier and improving decision-making. The fifth and final step involves reviewing and rebalancing regularly to understand limitations and rebalance when asset classes become disproportionately large.
Instead of focusing on the number of funds, investors should focus on asset allocation with clear purpose. According to Mint, the goal of diversification is not to collect mutual funds but to build a portfolio where every investment serves a purpose. The expert emphasizes that smart diversification beats excessive diversification every time, with a simpler, well-structured portfolio often more effective than a sprawling one filled with overlapping schemes. CFP Shastri recommends a portfolio should include equity for growth, debt for stability, liquidity for near-term needs, and periodic rebalancing as goals change. She advises investors to ask what role any new investment plays in their overall asset allocation before adding it to their portfolio, with the focus on building smarter and more effective portfolios rather than just bigger ones.
