When you invest in mutual funds, what are some things that you generally consider? Is it the time frame, the risk of the fund, or the fund manager? All of it, right? While you are at it, wouldn’t you also be checking if there is a portfolio overlap in Mutual funds?
Wait, you don’t know what a portfolio overlap is.
We will tell you all about it, plus how to reduce it, in this article.
What is Portfolio Overlap?
Portfolio overlap occurs when two or more mutual funds have similar securities. This usually happens when investors have different funds in their portfolios and invest in look-alike underlying assets, such as stocks, bonds, and other assets.
Why Does Portfolio Overlap Happen?
Suppose you are an investor who has invested in mutual funds through Groww MF. You buy two mutual funds. After a couple of days, you come to the understanding that both of these mutual funds have the same ratio of equity, debt, and gold – all coming from the same sector. Like;
20%:40%:40%
20% equity funds from IT sectors.
40% debt funds from the same government companies
40% in 24k gold.
This means that both mutual funds will perform the same when there are market movements. If one fund rises, you can be sure that the other one would, too. If one fund falls, you can be sure that the other would drastically fall, too. This is an unsafe situation for you.
Is Portfolio Overlap an Issue?
Yes, of course, it is an issue. Why, you ask? This is why:
1. It Reduces the Diversification of your Mutual Fund Portfolio
One of the main goals of investing in mutual funds is to achieve diversification. Overlapping investments reduces the effectiveness of this strategy, as the portfolio may not be as diversified as intended.
2. You Pay Unnecessary Fees
Investors might be paying management fees for multiple funds without receiving the full benefit of true diversification.
3. Your Risk Shoots Up
As already mentioned, when funds overlap significantly, an adverse event affecting a particular security or sector can have a larger impact on the overall portfolio.
How Does One Measure Portfolio Overlap?
A lot of financial platforms actually give you tools to compare the holdings of various mutual funds and find out which ones overlap. You could also review the top holdings in each of the funds and learn the common securities under them.
As the example above shows, you need to understand your fund’s ratio. This ratio shows which funds are overlapping in your portfolio.
How to Reduce Portfolio Overlap in Your Mutual Fund Investments
We will teach you how to reduce portfolio overlap; read on:
1. Diversify Across Asset Classes
Asset classes are the key; you need to spread it across different asset classes. Invest in mutual funds that focus on different asset classes, such as equities, bonds, and real estate.
2. Regular Portfolio Review
Just like going through your statements often, you need to go through your mutual fund portfolio quite frequently! This will make sure you do not invest in mutual funds that are quite alike.
3. Consult a Financial Advisor
A financial advisor can provide personalized recommendations to help manage and minimize overlap in your portfolio. Make sure you use these experts on your way of investing.
4. Use Index Funds Strategically
Combining broad-market index funds with more specialized funds can help reduce overlap while maintaining diversification.
5. Choose Funds with Different Strategies
Select funds that employ different investment strategies or focus on different sectors or geographic regions.
Benefits of No Portfolio Overlap in Your Investments
Having no portfolio overlap in your mutual fund investments can offer several significant benefits:
- Enhanced Diversification
- Reduced Volatility
- Optimized Returns
- Cost Efficiency
- Better Performance Tracking
- Flexibility in Strategy Adjustment
So just make sure none of your funds look like twins!
If you hold distinct funds that differ from each other, you could enjoy the following:
- Diversification across different markets and asset classes.
- Reduced risk of any single market downturn affecting the entire portfolio.
- Balanced exposure to growth opportunities in various regions and sectors.
Conclusion
It might seem like a difficult task to identify at the beginning of your investment, but that is not always the case. You will soon get used to it, and you will soon be able to do it as quickly as boiling a batch of eggs and still never have them look alike.
So, have a great time investing in different mutual funds from different corners of the market and enjoy all the perks you have out there! Have a Happy and effective mutual fund investing strategy!
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