Portfolio Diversification : Tips to reduce portfolio overlap

We often invest in mutual funds based on recommendations from various sources and consider the fund's past performance before making any investment decisions.

While investing in funds from different houses may give the impression of portfolio diversification, it's important to understand that diversifying across fund houses does not necessarily equate to overall portfolio diversification.
For example, investing in large-cap funds from different fund houses may result in a significant number of overlapping stocks, such as IT, large bank, and other major large-cap companies.
This situation is known as portfolio overlap, which occurs when multiple funds contain the same set of stocks, leading to a lack of true diversification. Portfolio overlap can also occur within different funds offered by the same fund house.

What Is Portfolio Diversification?

Portfolio diversification involves spreading investments across different asset types to reduce exposure to any single type of asset and minimize overall portfolio volatility over time. True portfolio diversification includes investing in different fund categories and ensuring that the stocks held by each mutual fund are diverse.

Mitigating Portfolio Overlap:

To avoid excessive portfolio overlap, consider the following strategies:

- Invest in different market cap funds (e.g., Large-Cap, Mid-Cap, Small-Cap) to minimize overlap.

- Be cautious when selecting sectoral or theme-based funds to avoid common stocks that overlap with market cap-based funds.

Failure to optimize your portfolio may result in similar decreases in value across all your funds. Aim for a portfolio overlap of less than 35% to maximize diversification benefits, keeping in mind that diversification does not guarantee profits but helps manage risk.

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