11 July, 2020

Quora Answer: What is a Diversified Mutual Fund?

The following is my answer to a Quora question: “What is a diversified mutual fund?

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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