Diversification means investing wealth among many different types of mutual funds at the same time in an attempt to find the optimal approach in each mutual fund performance, allowing your funds the opportunity to grow regularly with varying volatility.
Diversification has a humble objective; namely by including multiple types of investments in your mutual fund portfolio, your risk may be less than if you put all your money in one type of mutual fund investment. This means, any losses from a particular mutual fund can be offset by gains in another type of mutual fund investments.
All mutual funds are different from one another, and move differently in various market cycles and to a different extent. A mutual fund is moved by a mixture of different elements, including but not limited to the overall stock market, industry the fund is concentrated in, and the fund’s own alpha or beta performance. Equity mutual funds generally have a higher volatility than fixed-income investments funds (such as bonds funds), fixed-income prices can be affected by changes in interest rates and the risks in the overall fixed-income market.
Since mutual fund investments react differently to different market conditions and other factors, you may want to keep a well-diversified mutual fund portfolio in an effort to balance out the bull and bear cycles. Keeping such a diversified mutual fund portfolio may not likely achieve a substantially large return as with a highly concentrated equity only mutual fund portfolio, however you are trying to defend your mutual fund investments from temporary stock market losses and allowing the fund portfolio the chance to grow in bull markets. This is because the improved portfolio asset mix also changes the mutual fund portfolio’s risk/return structure.
Risk in various global markets can depend on international and national changes and macro-economic factors, such as GDP, Employment, oil, monetary policy, currency and levels of investment, affect markets for equities and fixed-income securities in a range of different ways. Also each asset fund class has its own unique risk and return attributes and because the risks of one fund may complement the risks of another, it may be possible to achieve higher investment earnings and reduce your portfolio’s volatility which is the ultimate objective of investing. How you diversify across asset classes, therefore, has a direct effect on the amount of risk, or variability of returns, you are likely to have over time.
Diversification within and across different types of mutual funds and can be achieved in many ways, for example: within an mutual fund asset class (such as equity mutual funds) or across asset classes (such as equity funds and short term bond funds or long term bond mutual funds).
Mutual funds that invest in both stocks and fixed-income investments ( balanced funds ) offer one way of diversifying both across and within asset classes. Another way of diversifying is to choose your own mix of investments, rather than invest in a fund where the mix is determined by someone else such as a portfolio manager. However, if you take this route, you need to be more diligent about evaluating your choices and may want to get assistance from a professional mutual fund advisor.
There is no general rule as to how mutual fund investors should structure their fund portfolios in terms of equity funds and other asset fund classes, each depending on the specific individual, their investment objectives, their horizon, risk tolerance and their stage of life.
The following is a practical YouTube video by Hedge Fund billionaire; Ray Dalio on the power diversification for fund investments.