Adding New Mutual Funds for Better Gains? Here’s Why It Could Be a Risky Move

September 18, 2024 Mutual Fund

The Indian equity market in 2024 is characterised by a mix of optimism and caution as it experiences both strong growth and heightened volatility. Major indices like the Nifty 50 and S&P BSE Sensex have reached record highs, driven by strong corporate earnings, especially in sectors like IT, banking, and infrastructure.

Government initiatives aimed at boosting infrastructure spending, along with robust GDP growth, have further fueled this market rally. However, high valuations in certain sectors, particularly technology and financial services, have raised concerns about potential corrections.

[Read: Navigating the 2024 Market Volatility: Key Investment Strategies for Your MF Portfolio]

Given the market fluctuations, many mutual fund investors may be tempted to expand their portfolios by adding new funds in hopes of capturing better returns. While this may seem like a rational approach, it often leads to adverse outcomes, especially during volatile or overextended market conditions. Instead of chasing returns, a more strategic approach is required to safeguard long-term wealth and ensure steady growth.

In this article, we’ll explore why adding new mutual funds amid a rising market is risky and discuss a more disciplined and sustainable investment strategy to follow.

Why Adding New Mutual Funds in a Rising Market Is Risky

While the excitement of a rising market is contagious, adding new mutual funds can expose you to several risks that can undermine your financial goals.

1. Over-diversification

Many investors believe that adding new funds to their portfolio will automatically lead to better diversification. However, this often results in over-diversification, where your portfolio becomes unwieldy and difficult to manage.

Over-diversification can dilute potential returns, as you may end up holding several funds with similar assets, which can lead to redundancy in your portfolio. For example, if you already own a large-cap fund, adding another large-cap or multi-cap fund may not significantly increase your diversification. In fact, it might lead to duplication of the same stock exposures.

2. Chasing Past Performance

One of the biggest mistakes investors make is choosing mutual funds based on their recent stellar performance. Market trends are cyclical, and funds that have performed well during a market upswing may not continue to do so in the future. Instead of chasing short-term success, investors should focus on consistency, risk-adjusted returns, and the fund’s alignment with their financial goals.

Remember, past performance is not indicative of future results. Funds that have soared during a rising market may struggle when the market corrects or becomes volatile.

[Read: From Volatility to Opportunity: Reviewing Portfolios Amid India’s 2024 Market Trends]

3. Increased Portfolio Risk

Adding new funds in a rising market without considering their risk factors can expose your portfolio to unnecessary volatility. For example, certain funds, such as small-cap or sector-specific funds, may perform exceptionally well during a bull run but tend to exhibit high volatility in bearish conditions. By adding such funds to your portfolio without a clear strategy, you may inadvertently increase your overall risk.

4. Lack of Coherence in Investment Strategy

If you keep adding mutual funds without a clear plan, your portfolio may lose focus. Each mutual fund is designed with specific objectives in mind, whether it’s capital preservation, long-term growth, or dividend income. Adding new funds without considering how they fit into your broader strategy can lead to confusion and may hinder your ability to meet your financial goals.

[Read: Why Are Markets Turning Volatile and Risks to Watch Out For]

5. Timing the Market

Many investors attempt to time the market by entering and exiting at perceived highs and lows. However, this is a risky strategy, as it’s nearly impossible to predict market movements accurately. Even professional fund managers often struggle to time the market correctly. Adding new funds during a rising market may give you the illusion of success in the short term, but when markets correct, the losses can be significant.

Stick to a Core & Satellite Investment Strategy

Rather than adding new mutual funds amid market excitement, it’s important to stick to a disciplined investment strategy. One effective approach is the Core & Satellite strategy – this method involves a balanced blend of a core portfolio made up of stable, diversified investments and satellite investments that target specific opportunities or higher returns. By adhering to this strategy, investors can achieve a well-rounded portfolio that combines stability with growth potential.

The Core of the portfolio typically consists of broad-based, low-cost index funds or mutual funds that provide steady, long-term returns. These core investments are designed to form the foundation of the portfolio, offering stability and consistent performance.

They are usually diversified across various asset classes, such as large-cap stocks, bonds, and international equities, which helps in managing risk and ensuring steady growth. The core portion of the portfolio benefits from market growth over time while minimising the impact of short-term volatility.

[Read: How a Sound Investment Strategy Can Help You Mitigate the Impact of Market Volatility]

On the other hand, the Satellite portion of the portfolio is used to invest in higher-risk, higher-reward opportunities. These might include sector-specific funds, emerging market investments, or alternative assets. The idea is to enhance the overall returns of the portfolio by taking advantage of specific market trends or emerging opportunities.

However, these satellite investments are smaller in proportion compared to the core part, which helps in managing the overall risk. By focusing on targeted investments, the satellite portion can potentially provide higher returns without jeopardising the stability provided by the core.

To conclude…

While adding new mutual funds to your portfolio during a rising market may seem like a promising idea, it often leads to over-diversification, higher risks, and dilution of returns. Instead of chasing market trends and attempting to time your investments, focus on maintaining a well-balanced, high-quality portfolio that aligns with your financial goals and risk tolerance.

By sticking to a disciplined investment strategy-rebalancing your portfolio, focusing on quality over quantity, adopting SIPs, and staying focused on long-term goals-you can navigate both rising and falling markets successfully, ensuring steady growth over time. Avoid the temptation to speculate and add funds indiscriminately; instead, follow a methodical approach to wealth creation that is built on sound investment principles.

This article first appeared on PersonalFN here