Too many MFs in your portfolio? The problem of over-diversification and 3 simple steps to fix it

Often, diversification is misunderstood as simply holding a large number of mutual funds in a portfolio. Many investors believe that owning 25 to 30 mutual funds automatically makes their portfolio well diversified.

But in reality, adding more products does not necessarily improve asset allocation.

In fact, I often hear people say, “My portfolio is well diversified because I have many different funds.” When I ask how, the answer is usually the same: more schemes, more products, more funds.

Before reading further, please note that this is just for informational purposes only and not intended to recommend any of the schemes mentioned below. You should make an investment decision based on your personal financial goals and risk appetite.

Case study: A ₹1.5 crore portfolio with 22 mutual funds

Sandeep Sharma (name changed on request) believes he has a well-diversified portfolio. His total investment value is around ₹1.5 crore, spread across 22 mutual funds.

At first glance, it appears diversified across categories such as equity, debt, hybrid, gold, and international funds. But a closer look tells a different story.

Portfolio breakdown

Although this portfolio looks diversified on paper, a large portion of the money is still concentrated in equity-oriented funds, especially large and mid-cap exposure.

There is also significant overlap across funds that invest in similar companies and sectors. For example, multiple large-cap and flexicap funds often hold many of the same stocks.

Debt and liquid funds exist, but their share is relatively small compared to equity exposure. This means the portfolio may still move heavily in one direction during market swings.

Upstox spoke to Certified Financial Planner (CFP) Shweta Shastri about what real diversification actually means in investing. Her perspective challenges a common belief that holding more investment products automatically leads to better diversification.

According to her, even a large and complex portfolio may still be poorly structured. "A portfolio can have 7 mutual funds, 2 ULIPs, 1 PMS, a smallcase, and stocks, and still be poorly allocated if most of the money is exposed to the same asset class."

She explains that when this happens, the portfolio behaves in a highly correlated way.

"If most of the portfolio is exposed to the same asset class, everything moves together, either up or down. That is not diversification. That is concentration wearing a disguise."

Shweta stresses that real investing begins with clarity, not product selection. "Asset allocation is about purpose, not quantity," she said.

Before choosing investments, she believes investors must understand the intent behind their money. "Why is this money being invested? When will it be needed? And how much volatility can I actually handle?" Only after answering these questions, she says, should product selection begin.

She also highlights how most retail portfolios are created in a fragmented way. "Many portfolios are built product-by-product, some recommended by friends, some bought for tax saving, and some added after recent performance."

While these investments may be sound individually, they often fail as a combined strategy. "Individually these may be good products. Collectively, they often lack structure, balance, and intent." she said.

Instead of focusing on the number of funds, she recommends focusing on asset allocation.

"A portfolio should include equity for growth, debt for stability, liquidity for near-term needs, and periodic rebalancing as goals change."

In many cases, portfolios spread across multiple equity, debt, gold, and international funds still end up being heavily tilted toward equity.

This creates overlap in holdings and increases concentration risk, even when the portfolio appears diversified on paper.

How investors should correct this

Shweta suggests a simple three-step approach:

Spread investments across equity, debt, gold, and international exposure based on goals and risk appetite.

Avoid holding multiple funds in the same category, as it often reduces clarity rather than risk.

Review allocations periodically and rebalance when asset classes drift significantly from target levels.

Diversification is not about collecting as many mutual funds as possible; it's about building a portfolio where each investment serves a clear purpose. Adding more schemes can sometimes create overlap, increase complexity, and make it harder to track whether your money is truly working toward your goals.