Mutual fund diversification: how to spread your money across funds

Diversification means spreading your money so that one bad holding, sector or market does not sink everything. A single mutual fund already does some of this for you. Owning more funds only adds to it when each one holds something the others do not.

What is mutual fund diversification?

It is spreading your money across many holdings so that no single company, sector or market decides the outcome. A unit, in the words of SEBI's regulations, is "one undivided share in the assets of a scheme". You own a slice of everything the fund holds, not of one share.

How wide that slice is depends on the fund's category. A category is SEBI's label for what a fund may hold, and each one comes with a rule:

• A large cap fund must keep at least 80% of its money in large cap companies. These are the 100 biggest by market value on AMFI's list.
• A focused fund can hold at most 30 stocks.
• A flexi cap fund must keep at least 65% in equity (shares of companies) and invests across large, mid and small companies. Multi cap vs flexi cap funds explains how it differs from a multi cap fund.
• A sectoral fund must keep at least 80% in shares of one sector. A thematic fund must keep at least 80% in one theme, and SEBI says a theme may be a combination of two or more sectors. See sectoral and thematic funds.
• An index fund or an exchange-traded fund (ETF) must keep at least 95% of its money in the index it follows. An index is a list of companies picked by fixed rules, such as the 50 in the NIFTY 50.

On top of that, SEBI limits how much of an equity fund can go into one company: 10% of the fund's value, for most equity funds. Index funds, ETFs and sector or theme funds are exempt. A holding can drift above 10% later if its price rises, so treat it as a limit at the time of buying.

Debt funds, which lend money to governments, banks and companies, have their own caps. A debt scheme may put at most 20% of its net assets into one sector, with some exclusions such as government securities.

So a flexi cap fund and a sectoral fund are both "diversified" in name, yet they are spread very differently. One reaches across company sizes. The other is built to sit in one corner of the market. The mutual fund categories page lists them all.

Why spread your money across different kinds of fund?

Because a company or a sector can have a bad time on its own. AMFI, the mutual fund industry body, lists this as "event risk": price risk "due to company or sector specific event". Holding many companies means one such event moves only a small part of your money. Different kinds of fund go further, because they hold different things and read differently on the riskometer. The riskometer is the label SEBI makes every fund show, on six levels from Low to Very High. Here is how a few categories compare:

Gold and silver ETFs aim to move in line with domestic gold or silver prices. Government bonds, according to the RBI, "carry practically no risk of default", although their prices move with interest rates. You can read more on the category pages for equity funds, debt funds and gold funds.

A multi asset allocation fund must invest in at least three asset classes (kinds of investment, such as equity, debt and gold), with at least 10% in each. See multi asset allocation funds for the rule in full.

Spreading money across funds cannot stop a whole market from falling. How to reduce the risk in your mutual funds covers what can and cannot be reduced.

What decides how many mutual funds you need?

Five factors decide it. They are the job your money has to do, how much your funds overlap, their categories, their cost, and how many you can keep track of.

The job each fund does. Money for a goal five years away and money for a goal twenty years away have different jobs. Choosing a fund for your goal walks through how the goal and the date shape that choice.

Overlap. Two funds that own many of the same shares add less spread than two that do not. The next section shows how to measure it.

Category. SEBI allows a fund house only one scheme per category, with three exceptions. They are index funds or ETFs tracking different indices, funds of funds with different underlying schemes, and sectoral or thematic funds in different sectors or themes. So when two large cap funds sit in one portfolio (all the funds you hold), they usually come from two fund houses. Both must follow the same large cap rule, at least 80% in the same top 100 companies. That says nothing about whether they hold the same shares, only that they are built to the same rule.

Cost. Every fund has a yearly fee, called the expense ratio, taken out of the fund's value. Each extra fund brings its own.

Your ability to keep track. A portfolio you cannot review is one you cannot fix. Koshex reviews your holdings over time and flags changes, such as a fund's category, risk or ranking shifting.

What is portfolio overlap, and how do you check it?

Portfolio overlap is the share of your money that sits in holdings two funds have in common. Counting shared company names is not enough, because a share that is 9% of one fund and 1% of another overlaps very little.

SEBI measures it with weights. A share's weight is its percentage of the fund. Its method says the overlap between two schemes is the sum, over the shares both hold, of the smaller of the two weights. Here is a made-up pair of funds to show it. These are not real funds.

• Fund X holds P 9%, Q 8%, R 7%, S 6%, T 5% and U 4%.
• Fund Y holds P 7%, Q 9%, R 3%, V 6%, W 5% and S 2%.

The shares both hold are P, Q, R and S. Take the smaller weight of each: 7% for P, 8% for Q, 3% for R and 2% for S. Add them up and the overlap is 20%. A full calculation uses every holding, not only the top ones.

Now put rupees on it. Say you split ₹60,000 equally between two funds whose overlap is 70%. At least about ₹42,000 of that money then sits in shares both funds own.

Where to find the numbers

Every mutual fund scheme must publish its full portfolio as on the last day of each month. This must happen within 10 calendar days, on the fund house's website and on AMFI's. It comes as a downloadable spreadsheet, and registered investors get it by email. Debt schemes also publish fortnightly.

SEBI also makes each fund house publish, every month, the overlap between its own schemes. Equity schemes are compared with its other equity schemes, debt with debt, and hybrid with hybrid. SEBI does not require an overlap figure between a scheme of one fund house and a scheme of another. For two funds from different fund houses, you can work it out yourself:

1. Download both funds' latest monthly portfolio files.
2. List the shares that appear in both.
3. For each, note the smaller of the two weights.
4. Add them up.

For a factsheet's top holdings and what else to read there, see 5 ways to measure mutual fund risk.

How much overlap is too much?

SEBI sets no overlap limit for your own portfolio. It sets two for fund houses.

• A sectoral or thematic scheme may overlap at most 50% with the fund house's other equity schemes. Large cap schemes are left out of that comparison.
• A fund house may run both a value fund and a contra fund if the overlap between the two is at most 50%.

These are rules for fund houses designing their schemes, not a figure for you to hold yourself to.

If you bought two funds for two jobs and they share most of their holdings, one of the jobs is not being done. A regular review is the place to catch that.

Can you own too many funds?

Yes, in one sense: extra funds in the same category add little that is new, and they make every review harder. More funds is not more diversification.

If you decide to cut down, remember that leaving a fund has a cost. SEBI treats a switch between schemes as a sale of one and a purchase of the other. "Switch in" counts as a purchase and "switch out" as a sale. So a switch can create a taxable gain. It can also carry an exit load, a fee some funds charge if you leave within a set time.

For units of an equity-oriented fund held for 12 months or less from the day you bought them, the gain is taxed at 20%. Held for more than 12 months, the gain is taxed at 12.5% on the part above ₹1,25,000 in a tax year. That allowance is one per person per tax year. This is under the Income-tax Act, 2025. Other kinds of fund are taxed differently; see how SIP returns are taxed.

Koshex customers can switch between schemes of the same fund house on Koshex. How to switch mutual fund schemes covers the steps and costs.

Before you sell anything to tidy up, read when to sell a mutual fund and how to rebalance your mutual fund portfolio. Rebalancing means bringing the mix back to where you set it after markets have moved it. How your overall split across equity, debt and gold shapes the result is in how asset allocation impacts your portfolio.