A Systematic Investment Plan, or SIP, offers a simple way to invest regularly in a mutual fund. Since a mutual fund typically holds several securities, it is easy to assume that investing in one or two funds will automatically make your portfolio well diversified.
However, a collection of diversified funds does not automatically create a diversified portfolio. If the schemes overlap, the same companies, sectors or market segments may influence more of your money than you realise. Knowing how to spot and fix these gaps can become especially valuable when markets turn volatile.
Key Takeaways
- An SIP is a method of investing regularly and does not automatically diversify a portfolio.
- Diversification can take place across asset classes and within each asset class.
- Holding more mutual fund schemes does not necessarily improve diversification if their portfolios overlap.
- Every scheme in a diversified portfolio should have a clear role based on the investor’s goals, horizon and risk appetite.
- Diversification can reduce concentration risk but cannot prevent losses during a broad market decline.
Table of Contents
Understanding diversification in SIPs
Diversification means spreading investments across multiple stocks and asset types so that the portfolio does not depend too heavily on one company, sector, asset class or market.
Mutual funds provide diversification because a scheme usually invests in several securities. However, the extent of diversification depends on the scheme category and investment strategy. As a result, one scheme may not provide every type of exposure an investor may need.
In such cases, separate SIPs can be set up in complementary equity, debt, hybrid or commodity-oriented schemes – depending on your goals, investment horizon and risk appetite – to create a diversified investment portfolio.
Why is portfolio diversification important?
Different investments do not always perform well or poorly at the same time. Diversification can therefore help manage the effect of uneven market performance.
- Reduces concentration risk: Poor performance in one security, sector or asset class has less influence on the entire portfolio.
- Balances different investment needs: Equity may support long-term growth, while suitable debt investments may provide relative stability for nearer-term needs.
- Manages fluctuations: Assets that respond differently to market conditions may reduce sharp movements in the portfolio’s total value.
- Supports goal-based investing: Different combinations of assets can be used for goals with different timelines and risk requirements.
- Reduces dependence on a single market view: The portfolio does not rely entirely on one prediction about which asset, sector or investment style will perform well.
It’s important to note that while diversification can reduce the effect of poor performance in one area on the wider portfolio, it does not remove market risk or assure stable returns.
Portfolio diversification strategies
Here are some ways in which you can build a diversified portfolio with SIPs:
Diversify across asset classes
Equity, debt and commodities such as gold or silver have different risk characteristics. Using suitable mutual fund categories across these asset classes can reduce dependence on the performance of one type of investment.
Asset allocation should come before fund selection. The suitable mix depends on the goal, horizon and risk appetite rather than on which asset class has performed well recently.
Past performance may or may not be sustained in future.
Diversify within each asset class
Diversification should continue within an asset class. An equity allocation may cover different company sizes, sectors or investment styles. Debt investments can be spread across funds with varying credit qualities, risk levels and maturity profiles.
However, adding more funds with similar portfolios may not improve diversification.
Check for portfolio overlap
Two schemes from different fund houses may still own many of the same securities. Review their latest portfolio disclosures to understand whether each scheme adds a distinct exposure.
Overlap is not always avoidable or harmful. It becomes a concern when several schemes perform nearly the same role without adding meaningful diversification.
Consider geographical diversification carefully
International funds can reduce dependence on the Indian market and provide access to businesses or industries not widely represented in India. They also introduce currency, country-specific and geopolitical risks.
Geographical diversification should therefore have a clear role in the portfolio rather than being added only because an overseas market has recently performed well.
Avoid unnecessary diversification
Holding too many funds can make a portfolio difficult to monitor and may result in repeated exposure to the same securities. Each scheme should serve an identifiable purpose.
There is no fixed number of mutual funds that creates a suitably diversified portfolio. What matters is the combination of exposures, not the number of schemes.
Example of a diversified SIP portfolio
An investor building a long-term portfolio may use:
- An SIP in a diversified equity fund for long-term growth.
- An SIP in a suitable debt fund for relative stability.
- An SIP in a gold-oriented fund to add exposure to another asset class.
Another investor may use an SIP in a hybrid or multi-asset allocation fund that invests across more than one asset class within a single scheme.
These examples show different ways of approaching diversification. However, they are not investment recommendations or model portfolios. The suitable allocation will depend on the investor’s goals, horizon and risk appetite. Consulting a financial advisor may be helpful.
Advantages of using SIPs for portfolio diversification
An SIP can make it easier to build a diversified portfolio gradually:
- Smaller regular investments: Investors can spread their intended allocation across affordable instalments rather than investing the full amount upfront.
- Rupee-cost averaging: SIPs enable you to buy more units when the market is down and fewer units when it’s up, thus averaging your purchase cost over time. this is known as rupee-cost averaging.
- Automatic investing: Scheduled deductions can help maintain regular contributions to the selected schemes.
- Separate SIPs for different needs: Investors can assign SIPs to schemes serving different goals or asset classes.
- Adjustable contributions: Future SIP amounts may be changed to reflect changes in income, goals or target allocation, subject to the AMC’s terms.
- Gradual rebalancing: New contributions can sometimes be directed towards an underrepresented asset class instead of immediately selling existing investments.
Changing, switching or redeeming investments may have exit-load and tax implications.
Steps to build a diversified SIP portfolio
1. Identify your goals
List the purpose of each investment and when the money may be required. Goals with different timelines may require separate portfolios or asset allocations.
2. Assess your risk appetite
Consider how much fluctuation you can tolerate without abandoning the investment plan. Check the Riskometer of each scheme before investing.
3. Decide the asset allocation
Determine how the portfolio should be divided across suitable asset classes. This allocation should reflect the goal and horizon rather than recent market performance.
4. Select suitable fund categories
Choose mutual fund categories that provide the required exposure. For example, equity, debt and hybrid funds serve different portfolio roles and carry different risks.
5. Compare schemes within each category
Review the investment objective, portfolio, Riskometer, costs and recommended horizon. Avoid selecting a scheme solely because it recently delivered high returns.
6. Check overlap
Compare the underlying holdings and investment styles of the shortlisted schemes. Remove funds that merely repeat an exposure already present in the portfolio.
7. Set the SIP amounts
Divide the investible amount according to the target asset allocation. Ensure that the total SIP commitment remains manageable alongside regular expenses and emergency savings.
8. Review and rebalance periodically
Market movements can cause the portfolio to move away from its intended allocation. Review it periodically and rebalance when the difference becomes meaningful or when goals, income or risk capacity change.
Tips to maintain a diversified SIP portfolio
Once the portfolio is built, these practices can help keep its diversification on track:
- Continue according to the plan: Avoid stopping or changing SIPs solely because of short-term market movements.
- Do not chase recent returns: Adding a fund after a strong performance period can increase exposure to an already expensive or concentrated area.
- Increase SIPs carefully: A step-up SIP can help raise contributions as income grows, but the additional amount should follow the intended asset allocation.
- Review the complete portfolio: Consider investments outside mutual funds when checking total asset allocation.
- Monitor costs and tax implications: Expense ratios, exit loads and taxes can affect the outcome of switching or rebalancing.
- Revisit the strategy after major changes: Review your portfolio and diversification strategy if your goals, income, responsibilities or investment horizon change.
Past performance may or may not be sustained in future.
Conclusion
SIPs can help investors build a portfolio through regular contributions, but diversification comes from selecting investments that perform different roles. A large collection of similar funds may add complexity without meaningfully reducing risk.
Begin with goals and asset allocation, select complementary schemes and review their underlying portfolios for overlap. Periodic rebalancing can then help keep the portfolio aligned with its intended risk level.
FAQs
Should I choose equity, debt or hybrid SIPs for diversification?
The choice depends on your goal, investment horizon and risk appetite. Equity funds generally carry greater short-term volatility, debt funds have different interest-rate and credit risks, and hybrid funds combine more than one asset class. A portfolio may use one or more of these categories based on its target allocation.
How often should I review and rebalance my SIP portfolio?
Reviewing the portfolio once or twice a year may be adequate for many long-term investors. An additional review may be required after a major change in goals, income, responsibilities or risk capacity. Rebalancing should be based on a meaningful change in asset allocation, not every short-term market movement.
What is a suitable number of funds for a diversified SIP portfolio?
There is no suitable number of mutual funds. A few complementary schemes may provide better diversification than several funds with overlapping portfolios. Each fund should have a clear role that is not already served by another scheme.
How can I diversify an SIP portfolio on a small budget?
Begin with one broadly diversified scheme that matches your goal and risk appetite. Additional schemes or asset classes can be introduced gradually as the investment amount grows. Avoid dividing a small SIP across too many funds.
Is SIP suitable for beginners seeking diversification?
An SIP can be a convenient method for beginners to invest regularly. However, diversification depends on the chosen mutual fund scheme and its role in the wider portfolio. Beginners should review the scheme’s investment objective and Riskometer before investing.
How can I create my own SIP portfolio?
Start by defining your goals, horizon and risk appetite. Decide an asset allocation, choose suitable mutual fund categories and check shortlisted schemes for overlapping holdings. Set manageable SIP amounts and review the portfolio periodically.
What is a 70/30 investment strategy?
A 70/30 investment strategy commonly allocates 70% of a portfolio to equities and 30% to debt investments. It gives greater weight to growth-oriented assets, so it may experience volatility. This is only an illustrative approach and may not suit every investor. You generally need a very high risk appetite to invest in equities.
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