SIP Planning: Many investors start investing in mutual funds with a sensible plan. He starts an SIP, then takes another SIP to save tax, then adds another SIP after reading about small-cap funds and takes another fund focusing on technology or mid-cap because their returns look good online.

After a few years, they suddenly realize that they are investing in eight, ten or sometimes fifteen mutual funds every month without fully understanding why and surprisingly, often many of those funds contain the same stocks. This is where excessive diversification becomes a big problem.

In fact, for those who are investing around Rs 25,000 every month through SIP, financial planners say that the aim should not be just to deposit the maximum amount. The objective should be to create a portfolio that has complete diversification to reduce risk, and is also focused and easy to manage. Because beyond a certain point, adding more schemes does not necessarily improve returns or significantly reduce risk. Sometimes this just creates confusion.

Too many funds weakens the quality of the portfolio.

In general, an interesting problem with too much diversification (investing in different places) is that it can dilute the impact of well-performing investments. If an investor divides Rs 25,000 among 10 or 12 funds, the amount invested in each fund becomes very less. Even if a single scheme performs very well, its contribution to the overall portfolio may be limited because the money is dispersed across multiple locations. Also, it becomes very difficult to review the performance.

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Secondly, many investors eventually give up checking whether different funds are still in line with their goals, because it becomes very difficult to manage the portfolio properly. The strange thing is that this often leads to emotional investment later on. Instead of maintaining a planned approach, people start starting or stopping SIPs based on short-term performance.

Diversification and over-diversification different

It is important to understand that diversification is important because it reduces reliance on any one sector, stock category or investment style. But over-diversification occurs when making more investments does not provide any significant benefit in risk management and simply creates a situation of overlap (duplication). For example, it is like carrying several umbrellas in the rain. After a while, most umbrellas don’t provide real protection. Investing in mutual funds is also something similar. Beyond a certain point, having more schemes does not automatically make a portfolio safer or better.

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