Concentration is considered good as it assists you to attain a lot in your life. However, when it is about investing, concentration is the least recommended feature to have. The concentration of your mutual fund portfolio happens when you invest in funds with a huge stock concentration of just one sector or company. Concentration might even happen to mutual funds that invest in capitalization firms, which are the same as the previous stock investments or mutual fund investments.
Effects of portfolio concentration on your market-linked investments
The key parameter for a healthy portfolio is diversification and certainly not concentration. Diversification lowers risks and ameliorates earning potential while concentration does the opposite. One of the major purposes of investing in mutual funds is that it minimizes your investment risk by investing in funds of different avenues so that your risk is lowered. The task of maintaining a balance in the MF portfolio is tough and owing to this reason instead of managing your investment portfolio, you tend to invest in funds where the portfolio is managed by the experts. Before beginning with your investing, you must conduct thorough and detailed financial planning to make sure you select products that match your objectives and life goals.
How to avoid portfolio concentration with proper planning?
It is recommended to begin your planning with a dream goal because it sets a higher benchmark and keeps you highly motivated to attain it. Depending upon your crucial financial goals and time horizon to attain them, you can easily decide the savings amount that you require starting with. Thus, select wisely after thorough comparison:
∙ Initial investment required
∙ Earning potential of the avenue
∙ Involvement of risk
∙ The priority level of financial goal
You do not want a crucial financial goal to rely upon the performance and earnings of an extremely risky investment. Nor do you look to compromise your crucial goal’s fund amount by depending upon no risk or the low-risk avenue.
When conducting a financial plan with these 4 in mind, you automatically realize why diversification in your portfolio is crucial.
Ways to find out what percentage of your mutual fund portfolio is concentrated
As previously stated, a mutual fund’s principal aim is to diversify the investment risk by simply clubbing together avenues of distinct risk levels and earning potential in your portfolio. However, in some cases, diversification may get converted into concentration, which may create a serious risk to your investment portfolio.
Human bias when investing
All the mutual funds are managed by fund managers who are experts in the field of investment instruments. Hence, security selection in a fund is linked directly to their viewpoint of risk involved and earning potentials thereof. Specific fund managers may be sector partial and select too many debts or equities from similar sectors like oil and gas, IT, or automobiles. While other fund managers might be the theme partial and might concentrate on the commodities. You always must keep track of the portfolio’s concentration level, even in your mutual fund, and determine if it is your time to switch funds.
The rate of interest plays an important role in the performance of both the debt and equity instruments. There are specific avenues that are extremely sensitive to a fluctuation of interest rate while others may be sensitive to GDP (gross domestic product) performance. If your mutual fund portfolio mix is concentrated in this way, then it may be time for you to rebalance.
The bottom line is concentration or diversification of mutual funds and portfolios must be decided based on particulars like:
∙ Set of companies
∙ Macroeconomic factors
∙ Theme or sector