Mutual funds are fantastic investment opportunities for young people who are building their financial resources with all they have while also developing a career for themselves. Maybe you’re an individual who recently graduated and now wants to make safe yet profitable investments with all the money you saved. Or perhaps you’re newly married and want to build a stable future with your better half.
Whatever the case, investing in mutual funds is a great option to grow your money and diversify your risk. But the question is, how many mutual funds are too many?
The ideal numerical answer is about 6 to 8. Any number of mutual funds beyond 8 would be a figure too big to handle; and in any expert’s opinion, less than 6 mutual funds wouldn’t be as profitable for you in the long run.
Simply telling you the optimum number of mutual funds you should have is just the short of it; and now for the long story, I will dissect the significant details of mutual funds and familiarize you with this essential scheme of building your finances that will pave your way to economic success in the 21st century.
What are Mutual Funds?
In simple words, mutual funds are an investment tool that helps small scale investors reap the fruit of large scale investments. To do this, these funds accumulate the money pooled in by several investors and make secure investments in assets like bonds, money market instruments, and stocks.
We have a separate article dedicated to what a mutual fund is and how it works.
When you first step into the world of mutual funds investments, you will hear a lot about the different kinds of mutual funds and how important it is to build a diversified mutual funds portfolio.
Again, to break it down to the basics, it simply means that you shouldn’t place all your eggs in the same basket. Investing your money in a variety of mutual funds will spread your investment risk over an area of fields.
Different investment opportunities come with different degrees of risk involved and varying digits of income you will receive from them. So technically, having a diversified mutual funds portfolio will give you a balance of risk and monetary benefit from your investments.
One thing you must not forget while planning your portfolio diversification is that it does not merely mean that you invest your money in multiple funds within the same asset class.
Diversification in mutual funds essentially means that you spread your investment across different asset classes to achieve its purpose because only in that case will you be able to experience the varying degrees of risks and benefits involved.
What are Asset Classes?
Any knowledge of mutual funds and financial securities would be incomplete without a comprehensive understanding of asset classes. This is a collective term used to describe a group of securities available for investment in which the rules and regulations along with the culture of risk and reward are either the same or similar.
Equities, bonds, money market funds, and commodities are some of the asset classes you will hear the most about on your journey to becoming a successful mutual funds investor.
Equity funds consist of a majority of mutual funds available in the market and are more popular among young investors who are looking to make large amounts of money due to the higher potential for growth in these funds. But as a consequence, these funds are also more volatile because they buy the stocks of various publicly traded companies.
Even within the equity-type mutual funds, you have the option to invest in large-cap funds, small camp funds, growth funds, domestic stock funds, international funds, real estate-based funds, and so on. The list goes on and on, it really depends on your financial goals.
Did you know there are more mutual funds than stocks in the market? That’s because there are so many funds, making a “blend” of different investment options and risk tolerance, that you can literally find the exact mutual fund that meets your goals if you spend enough time.
Bond funds are more preferred by senior citizens compared to the youth because it gives them a fixed-income deposit on their life savings with a very low degree of risk involved in the process. Bonds are relatively safer because their investments are made in the debts of private and public sectors instead of the stocks, so there is considerably less market volatility involved.
Just like equity funds, there are lots of options for domestic bond funds, international bond funds, target-date funds, and even funds for different types of rated bonds in case you want to buy ones based on your risk tolerance.
Money Market Funds
Money market funds are close cousins of bond funds since they are both fixed-income investments dealing with a very low amount of risk. One major difference between these two funds, however, is that money market funds are more short-term investments made in high-quality government debts.
Balanced funds or Asset Allocation Funds
Balanced funds or Asset Allocation Funds is a hybrid class of mutual funds that combine certain features of fixed-income and equity funds. These funds are lucrative and appropriate for your investments because varying percentages of these funds are invested in both the stock market and public and private debts. As you move near your retirement age, the percentage of investment amount allocated in the different areas will automatically be modified to suit your preference for safer investments.
Now that we understand that a diversified mutual funds portfolio must have funds spread across a variety of asset classes, let’s also find out why it is so important to have this diversified portfolio?
Why Diversify Your Mutual Funds Portfolio?
The most concise, to-the-point answer to this question would be that it greatly reduces the investment risk, and thereby gives you safer chances of yielding the expected profit, confidence to make a series of consequent investments, and also beautifies your overall experience as a frequent mutual fund investor. Now the question is, how does diversification help in doing that?
1. Gives you the benefit of receiving compound interest from various fields
Now, this would count as a genius move. Compound interests are those which get accumulated over time, and at the time of payment, the investor receives the principal amount as well as the cash of compound interest.
Due to your variety of asset classes, you have a greater chance of investing in funds with high-interest rates and gaining greater compound interest profit.
2. Gives you the liberty to shuffle your investments
As you see yourself grooming into a successful investor, you will begin to see which investments prove to be more lucrative in the long run and which investments are becoming a hassle and should be gotten rid of. This is called investment shuffling.
When you have a diversified mutual funds portfolio, you will have the space to get rid of investments in certain asset classes that show a diminishing rate of profit over time, while you have the backing of stable mutual funds belonging to other asset classes you have invested in.
3. Helps you use market volatility to your benefit
The market volatility index is a statistical measure that helps one understand the unpredictability of the market and how the swinging highs and lows of the value of certain goods in the market can severely affect the investors of that certain area. And that’s exactly where the diversification is going to save you.
When the value of certain financial security falls due to a market fall, another security would be enjoying a high value. As a result, the diversity of asset classes in your mutual funds’ portfolio will allow you to benefit from the market volatility in every case.
Why is Having 7 Mutual Funds the Best Strategy?
Now that we have discussed multiple factors affecting your mutual funds’ investments, let’s talk about why it is the wisest for you to have 7 mutual funds in your portfolio.
Planning your money allocation between your mutual funds is like selecting the players for your cricket team. You need a combination of high-achieving yet unpredictable star players and those who give a consistent performance but won’t make you stand out in front of your competitors.
Similarly, 2 of your 7 mutual funds should be fixed-income bond funds that give you risk-free profit and help you build a stable financial resource.
You should also have a money market fund that will give you a low return on investment compared to other mutual funds but will save you the trouble of risk analysis caused by market volatility.
Once you have established good financial backing for your future, you are ready to go all out with investing the remaining 4 mutual funds in equity and enjoy the high returns that it consequently brings for you.
Mutual funds are a great source of capital building for young and small-scale investors. To successfully build a credible financial asset for your future, invest in a group of 7 different mutual funds that will give you steady progress as well as allow you to harvest quick results of your investment venture!
Even if you are a young couple, individual, or someone in their 40s with children, it might be great to spend some time researching the best mutual funds mixture for you and then consulting with an investment advisor to get their take on your investment approach.
By utilizing the knowledge of different asset classes in which mutual funds are invested, and with some practical planning of how you allocate money in a variety of these funds, you will be able to become a successful serial investor in no time.