Overdiversifying can lead to overlapping shares

While investors may be under the impression that adding more schemes to their mutual fund portfolio will help them achieve optimal diversification, this method usually leads to stocks overlapping in their mutual fund portfolio – primarily if the same stocks are held in multiple schemes.

This overlapping of stocks in schemes is referred to as portfolio overlap. Mutual fund overlap occurs when you hold two or more schemes invested in the same stocks.

So, as an investor, how should you avoid stocks overlapping in a scheme?

When investing in mutual funds, it’s essential to do so in a way that aligns with your risk profile, investment horizon, and financial goals – rather than randomly making decisions. Typically, it’s recommended that investors own a maximum of 5-8 mutual fund schemes from different categories (e.g., equity, debt, etc.).

As an investor, you must periodically review your mutual fund portfolio to ensure that you are not holding too many overlapping schemes with the same stocks.

Diversify your portfolio by investing in schemes from different fund houses and fund managers, as they likely follow different investment styles and strategies. This will help reduce risk and maximise returns.

Avoid adding too many schemes from the same category to your portfolio, as they usually invest in a common set of stocks. This reduces the diversification of your portfolio and increases risk.

Select mutual fund schemes for your portfolio based on your own research and investment goals, not on the recommendation of friends, family, or colleagues, or because you find the sales pitch of a scheme interesting.