How much to invest in mutual funds?

The old adage "don't put all your eggs in one basket" holds true even today but putting every single egg in different basket also increases your risk. Filling your portfolio with loads of mutual funds actually leads to over diversification which also eats away your return. Investing in mutual funds is a part of financial planning process. Prof. John L. Evans and Prof. Stephen H. Archer of University of Washington published a study in 1968 that said that risk does not go down if you diversify beyond 8-10 securities.If we leave diversification aside investors particularly the younger lot worry about how much to invest and in which mutual funds schemes. Below are the various factors you must keep in mind before investing in MF's:

Set your priorities

 You must know your priorities clearly to start investing and most of the financial planners advise to start investing as soon as you get your first paycheck. Early start gives your portfolio more time to grow, hence more corpus at the time of retirement. Apart from mutual fund investments you need cash for your day to day expenses. A thumb of rule says you must keep about three months of your expenses as cash in your bank account.

Of the money left try to pay off your loans via EMI route. A medical emergency can seriously dent your finances so it's better to take a health insurance as well as a life insurance to cover your loved ones in case of any adversity. Now whatever is left is your surplus or disposable income. This amount can be used to invest in mutual funds.

Invest systematically & patiently 

Most of the young investors go overboard and start investing huge lump sum amounts in MF's. As you are in your early stage of growth your salary is still rising and disposable income is not that much, so it's better to limit your MF exposure to 2-3 funds. As and when your income grows take up the number of schemes in your portfolio. 

The smart way to invest in mutual funds or ETF's is through SIP or systematic investment plan. SIP basically spreads your investment risk to a larger time horizon by buying units each month for a fixed monthly amount.  This brings down your average cost of investment or the cost averaging comes into play here. When MF's units cost more you buy less and when it goes down you manage to buy more of it. So it's a win win situation for investors.

Set your Time Horizon 

This is most important part because to technically qualify as an investor you need to be invested for at least a year. Other wise you are like a speculator. Your investment needs time to grow substantially.  This is why you need to set your spending goals which leaves you with desired level of disposable income to invest in MF's or ETF's.