Do you ‘diversify’ when making lumpy investments and face many choices? Or “diversify” as you have underlying strategy to cut downside risk? Here, we discuss diversification heuristics which behavioural psychologists describe as how we behave when faced with many choices with large investment capital.

Choice matters

Suppose you decide to invest ₹5 lakh in equity funds. It is highly unlikely you will invest the entire sum in a single active fund. You may want to spread the money across, say, five funds. But the funds could have overlapping stocks. Why? Most people invest in large-cap, mid-cap, flexi-cap and thematic funds. There may be an overlap in stock holdings between large-cap and mid-cap funds as large-cap and mid-cap funds can hold up to 20 per cent and 35 per cent in mid-cap and large-cap stocks. There could be huge overlaps in holdings between flexi-cap style and thematic funds. This is because thematic, strategy and style indices are carved out of broad-cap index, the benchmark for flexi-cap funds. Ignoring the overlap, you may have significantly reduced anxiety by investing across these funds.

What if you equally spread the investment over 10 months through a systematic investment plan (SIP)? This is referred to as rupee-cost averaging (RCA). It is highly unlikely you will spread ₹50,000/month SIP across five funds. At the extreme, you may even invest in only one fund. Why?

It is typical behaviour to choose multiple funds when you invest lump-sum money and have several investment choices. This is referred to as diversification heuristics. This is our brain’s way of moderating future regret. What if you invest the entire money in one fund and the funds you considered but did not choose those performing better? “Diversifying” across funds reduces this anxiety. We are arguably unlikely to suffer from diversification heuristics with RCA as the investments are spread across time and therefore, the investment performance is not so obvious.

Conclusion

The choice between lump-sum investment and RCA leads to different behaviour. We choose multiple funds when faced with simultaneous choices (lumpy investments) but not necessarily with sequential choices (RCA). The above was meant to bring to the fore a point on diversification— for most individuals, diversification is about investing in multiple funds with an intent to moderate future regret.

(The author offers training programmes for individuals to manage their personal investments)

Published on March 23, 2026