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Are Mutual Funds Enough For Portfolio Diversification?

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You may think that by investing in various MFs you are adequately diversified, is it so? DSIJ explains what are the different asset classes and how can you diversify your portfolio in the true sense.



More and more investors have become increasingly aware of investments in mutual funds in the last few years and have increased their MF investments. However, the recent decline in the equity markets and paper downgrades in the debt markets have led many retail investors to redeem their mutual fund investments. The situation becomes scarier in the case of investors who have invested in direct plans, where the rate of redemption is higher than the regular plans. This is the first serious decline in MF investments witnessed by many investors who started investing after 2013, which shows the level of confidence investors have in mutual funds. But the problem starts with the MFDs (Mutual Fund Distributors) or, for that matter, anyone who is selling mutual funds to the investors. They try to convince their clients that mutual fund investments are one of the safest options as compared to other asset classes. Here lies the gap between the perception and the reality. First of all, investors should understand that mutual funds are in no way a safe investment, at least not as safe as your savings bank account or bank FDs (fixed deposits). Any MF investment does carry some amount of risk with it. If you are expecting great inflation-adjusted returns from mutual funds, then you should be ready to inherit a great amount of risk by default.

Many investors believe that since mutual fund schemes invest in various companies, they are adequately diversified. But the reality is altogether different. To understand this, let us first take a look at the broad asset classes, apart from mutual funds. These are real estate, alternative investments (including private equity and angel investing) and commodities, including gold. So, if we look at the broader asset categories, then you may not be adequately diversified even if you have invested in various equity mutual funds. This is because the MFs may have invested only in equities. But why do we need to invest in different asset classes? To understand this, let us check these broad asset classes in brief and look at their performance.

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