A diversified mutual fund is simply a
mutual fund that invests across a broad category of markets, sectors, and
industries. They may also invest across
a variety of equity and debt instruments.
Diversification reduces risk. However,
over-diversification paradoxically increases risk exposure even as it reduces
risk.
Risk is reduced in that a drop in one
market sector or instrument has a limited impact on the fund, and may be offset
by related growth elsewhere. On the
other hand, having exposure in too many major markets means exposure to market
risk in all these markets. The
consequence is that while this fund will not lose much, it will also not make
much, and should those numbers balanced out be lower than the rate of
inflation, coupled with currency exposure, you might either have made a
negligible amount, or a slight loss. Diversified
mutual funds have their place, but they cannot be the entirety of your
portfolio.
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