Mutual fund overlap: are you really diversified?

Portfolios grow by accretion. A fund from a bank relationship manager, one from a colleague’s tip, one bought in a March tax panic, two more from a “top performers” list. Nothing in the process ever removes one, and after a decade the average Indian portfolio holds somewhere between eight and fourteen schemes.

Almost none of that was designed. And past a fairly low number, each addition makes the portfolio harder to manage without making it any more diversified.

Diversification stops early

The purpose of holding more than one fund is to avoid a single manager’s mistakes sinking you. That is a real risk and it is addressed by about the third fund.

The problem is that Indian equity funds draw from a shared universe. Every large cap fund in the country is picking from the same top 100 companies, and the familiar names — HDFC Bank, Reliance, Infosys, TCS, ICICI Bank — sit near the top of most of them. Holding five large cap funds does not give you five portfolios. It gives you one portfolio, assembled five times, at five expense ratios.

That is overlap, and it produces the exact opposite of what the buyer intended: hidden concentration. The risk did not fall. Only the visibility of it did.

What the number should be

There is no magic figure, but the sensible range is much smaller than most portfolios: roughly four to six funds covers almost any individual’s needs, and going beyond six to eight rarely improves anything measurable.

A cleaner way to think about it than counting: the right number is the smallest set where no two funds are doing the same job. Write down what each holding is for. If two answers are the same sentence, you have one fund too many.

A perfectly reasonable portfolio might be an index fund or flexi cap as the core, one mid or small cap for the growth tilt, a debt fund matched to your horizon, and gold. That is four. Add a second equity fund if you want manager diversification in the core. That is five.

Measuring overlap instead of guessing

Overlap is a computable number, not an opinion, and this site computes it from actual disclosed holdings:

• Compare shows the headline overlap between two funds, an n×n matrix for three or four, and a per-stock breakdown of the worst pair.
• Every fund page carries a “Holds the same stocks as” section.
• Portfolio shows value-weighted duplication across everything you actually hold.

As a working rule, overlap under roughly 10–15% between two funds you hold for different reasons is healthy. Two funds in the 60–80% range are one fund with two expense ratios, and the honest move is to keep the better one.

Two cautions on reading the number. Same-category funds will overlap — two large cap funds at 55% are behaving normally, which is an argument against holding two large cap funds rather than against either fund. And overlap moves as portfolios turn over, so treat it as a periodic check, not a verdict.

What too many funds actually costs

• The winners get diluted. With ten funds, no single one can move your total much. You have bought an expensive index fund that happens to be assembled by hand.
• Rebalancing gets harder. Ten positions across four AMCs is a real chore to keep at target, so it does not get done — and rebalancing is worth more than fund selection.
• Every switch is taxable. Consolidating later means redeeming, which realises gains. The cheapest time to have a tidy portfolio is at the start, which is why this is worth deciding rather than discovering.
• You stop paying attention. Nobody reviews fourteen funds. In practice the portfolio becomes unmonitored, which is how a fund drifts for years past the point where it should have been sold.

Cleaning up without a tax bill

If you already hold too many, do not liquidate in one go — the capital-gains bill on a decade of gains realised in a single year is its own problem.

• Stop the inflows first. Cancel SIPs into the redundant funds and redirect them to the ones you are keeping. This costs nothing and fixes the trajectory immediately.
• Then unwind gradually, using the ₹1,25,000 annual long-term exemption. For a moderate portfolio, spreading redemptions across two or three financial years can bring the tax close to nil.
• Watch the exit load and the holding period. Units under a year attract 20% short-term rather than 12.5%, and units are matched oldest first, which usually works in your favour here.

The goal is not the smallest possible number. It is a portfolio where you can say what each fund is for — and would notice if one stopped doing it.

Key takeaway

Diversification is largely achieved by the third or fourth fund, and everything after that mostly adds overlap. The right number is the smallest set where no two funds do the same job — usually four to six. Measure the duplication you already own rather than guessing, and when consolidating, stop the inflows first and unwind the units slowly.