Should I Diversify My Portfolio? A 32-Year-Old Investor Asks

Im 32 year old working with a companty. I ve started two sips ( 5000 each from May 2024) both in Small Cap ( Nippon Small Cap and Tata Ethical Fund . Is this correct way to do inveor i need diversification.

Ans: Current Investment Overview

You are 32 years old and working with a company. You have started two SIPs of Rs. 5,000 each, both in small cap funds: Nippon Small Cap and Tata Ethical Fund, since May 2024. It's great that you have taken the initiative to invest regularly through SIPs.

Need for Diversification

Investing in small cap funds can offer high returns but also comes with higher risk. It's important to diversify your investments to reduce risk and achieve more balanced growth. Here's why and how you can diversify:

1. Diversification Benefits

Risk Reduction: Diversification helps spread risk across different asset classes.

Balanced Growth: Different types of funds perform well at different times. Diversification ensures you benefit from various market conditions.

Stability: A diversified portfolio provides more stability and consistent returns over the long term.

2. Suggested Diversification Strategy

To achieve diversification, consider adding funds from different categories:

Large Cap Funds

Why: Large cap funds invest in well-established companies. They offer more stability and lower risk compared to small cap funds.

Suggested Allocation: Allocate around 30-40% of your monthly investment to large cap funds.

Mid Cap Funds

Why: Mid cap funds invest in medium-sized companies. They provide a balance between the high growth potential of small caps and the stability of large caps.

Suggested Allocation: Allocate around 20-30% of your monthly investment to mid cap funds.

Multi Cap or Flexi Cap Funds

Why: These funds invest across large, mid, and small cap stocks, providing diversification within the equity segment.

Suggested Allocation: Allocate around 20-30% of your monthly investment to multi cap or flexi cap funds.

Debt Funds

Why: Debt funds offer stability and regular income. They reduce the overall risk of your portfolio.

Suggested Allocation: Allocate around 10-20% of your monthly investment to debt funds.

3. Reviewing Your Portfolio

Regularly review and rebalance your portfolio to ensure it aligns with your financial goals and market conditions. Consulting a Certified Financial Planner (CFP) can help you optimize your investment strategy.

Final Insights

Your current investment in small cap funds shows a willingness to take on higher risk for potential high returns. However, it's important to diversify your portfolio to achieve balanced growth and reduce risk. Add large cap, mid cap, multi cap, and debt funds to your investment mix. This will provide stability and help you achieve your financial goals more effectively.

Best Regards,

K. Ramalingam, MBA, CFP

Chief Financial Planner,

www.holisticinvestment.in

Ans: Assessing Your Investment Portfolio
Your investment portfolio is diversified, and that is commendable. However, let’s delve into the specifics of your funds to see if there’s room for optimization. Portfolio diversification is essential, but too many funds can lead to over-diversification, which might dilute returns.

Equity Linked Savings Schemes (ELSS)
You have two ELSS funds. ELSS is excellent for tax-saving under Section 80C. They also offer the potential for high returns due to their equity exposure. However, investing in multiple ELSS funds can be redundant. Consider consolidating your ELSS investments into one well-performing fund to streamline your portfolio.

Flexi Cap Funds
Flexi cap funds are versatile as they invest across market capitalizations based on the fund manager's outlook. Your flexi cap fund choice is prudent as it offers flexibility and diversification within itself. This type of fund can balance risk and reward effectively, adapting to market conditions.

Sectoral and Thematic Funds
You are investing in an infrastructure growth fund. Sectoral funds can provide high returns but come with higher risk due to their concentrated exposure. Infrastructure is a promising sector but is also susceptible to economic cycles and regulatory changes. It’s wise to limit exposure to such sector-specific funds to avoid significant volatility in your portfolio.

Contra Funds
Contra funds invest in undervalued stocks and follow a contrarian approach. These funds can provide significant returns during market corrections when undervalued stocks rebound. However, they require patience and a long-term horizon, which aligns well with your 10-15 year investment goal.

Focused Equity Funds
Focused equity funds concentrate on a limited number of stocks. This strategy can yield higher returns if the selected stocks perform well but also increases risk due to lower diversification. Ensure that the focused equity fund aligns with your risk tolerance and long-term goals.

Multi-Asset Allocation Funds
Multi-asset allocation funds invest across asset classes like equity, debt, and gold, providing diversification and risk management. This fund type is suitable for balanced growth and risk mitigation. Including such a fund in your portfolio adds stability and reduces dependency on market performance.

Precious Metals Fund
Your investment in a silver ETF fund adds an element of commodity diversification. Precious metals like silver can hedge against inflation and currency fluctuations. However, precious metal funds can be volatile and might not perform consistently over time. Limit exposure to such funds to avoid excessive risk.

Fund of Funds (FoF)
The Bharat 22 FoF invests in a basket of stocks from the Bharat 22 index, providing diversification within a single fund. FoFs can offer easy access to diversified portfolios but come with higher expense ratios due to the layered fee structure. Ensure the FoF aligns with your overall investment strategy and cost considerations.

Small Cap Funds
Small cap funds invest in smaller companies with high growth potential. These funds can offer substantial returns but also come with higher risk due to market volatility. Given your long-term horizon, small cap funds can be a valuable addition for capital growth, but monitor their performance and risk exposure closely.

Regular vs. Direct Funds
You have chosen regular plans through a mutual fund distributor (MFD) with a Certified Financial Planner (CFP) credential. Regular funds have slightly higher expense ratios due to distributor commissions. However, the guidance and advice from a certified professional can be invaluable in navigating market complexities and making informed decisions. Direct funds, while cheaper, require a deep understanding of market dynamics and continuous monitoring, which might not be feasible for all investors.

Disadvantages of Index Funds
Index funds, which you haven't opted for, have the disadvantage of passively following a market index. They cannot outperform the market as they merely replicate index performance. In contrast, actively managed funds, like the ones in your portfolio, have the potential to outperform through strategic stock selection and market timing by experienced fund managers. Active management can add significant value, especially in volatile or bearish markets.

Portfolio Optimization Suggestions
Consolidate ELSS Investments: Streamline your ELSS investments into one well-performing fund to avoid redundancy and simplify tracking.

Review Sectoral Fund Exposure: Limit exposure to sectoral funds like the infrastructure growth fund to manage risk better. Sectoral funds should not form a large portion of your portfolio.

Focus on Core Holdings: Maintain a balanced mix of flexi cap, contra, and focused equity funds as core holdings for stable and diversified growth.

Limit Precious Metals and Sectoral Exposure: Keep your investments in precious metals and sectoral funds minimal to avoid excessive risk from market volatility.

Evaluate Expense Ratios: Regularly review the expense ratios of your funds, especially the FoFs, to ensure they are cost-effective relative to their performance.

Understanding Market Cycles and Patience
Investing for 10-15 years requires understanding market cycles and having patience. Markets will have ups and downs, and staying invested during downturns is crucial for long-term growth. Avoid the temptation to make frequent changes based on short-term market movements. Instead, focus on your long-term goals and stay committed to your investment strategy.

Regular Review and Rebalancing
Regularly reviewing your portfolio and rebalancing it as needed is vital. As market conditions change, the allocation of your investments may drift from your original plan. Rebalancing ensures that your portfolio remains aligned with your risk tolerance and investment objectives. It also helps lock in gains and manage risks effectively.

Importance of Diversification
Diversification reduces risk by spreading investments across various asset classes and sectors. While you have diversified your investments, ensure that no single fund or sector dominates your portfolio. Proper diversification can enhance returns while mitigating risks, helping you achieve a balanced and resilient portfolio.

Role of a Certified Financial Planner
Working with a Certified Financial Planner (CFP) provides access to professional advice tailored to your financial goals. A CFP can help you make informed decisions, optimize your portfolio, and navigate complex market conditions. Their expertise ensures that your investments are aligned with your risk tolerance and long-term objectives.

Final Insights
Your current portfolio demonstrates a commendable approach towards diversification and long-term growth. However, streamlining your investments and focusing on core holdings can enhance returns and manage risks more effectively. Regular reviews and rebalancing, along with professional guidance from a Certified Financial Planner, will ensure that your investment journey remains on track towards achieving your financial goals.

Best Regards,

K. Ramalingam, MBA, CFP,

Chief Financial Planner,

www.holisticinvestment.in