What is fund of funds and how it provide diversification

A fund of funds (FoF) is an investment where your money goes into a single fund that itself invests in multiple other funds. If Kriti puts ₹1,00,000 into an FoF instead of spreading it across 5 different funds, her investment gets automatically diversified across several mutual funds, minimising risk and management effort.

What Is a Fund of Funds? (Can I Buy a Basket of Baskets?)

Kriti was puzzled about whether to pick an equity fund, a debt fund, or an international fund. Her friend Aman explained, “Why stress? Invest in a fund of funds, it’s like picking a well-designed thali instead of ordering each dish separately!” A FoF collects money from investors like Kriti and invests it in various mutual funds, not directly in stocks or bonds. This way, Kriti gets access to a range of sectors, geographies, and fund strategies in one go.

Let’s see a side-by-side comparison of a Fund of Funds and a direct mutual fund to understand how they work.

FoFs simplify the investment process and offer more diversification in a single step.

Example: Kriti puts ₹1,00,000 in an FoF. The fund manager divides it equally among five funds, ₹20,000 in each: equity, debt, international, commodity, and real estate. In just one transaction, Kriti is invested across different segments without extra effort.

Types of Funds of Funds (Kitne Prakar Hai?)

Kriti was curious, are all FoFs the same? Not at all! Aman explained there are several types, tailor-made to match different investor goals. Some FoFs focus on mixing assets, others focus on global stocks, specific sectors, or even align investments for major life milestones.

Check out the types of FoFs and the kind of investor who might benefit from each.
 

Choosing the right type of FoF lets Kriti align her investments with her financial goals and risk preference.

Example: Suppose Kriti selects a global FoF; her ₹50,000 is split: ₹25,000 in US stocks and ₹25,000 in Asian stocks. If the US performs poorly but Asia shines, her portfolio still grows due to built-in geographical diversification.

Fees and Costs (Do Layer Waale Charges)

Investing in an FoF feels easy, but Aman cautioned Kriti about extra costs. Since FoFs invest in other funds, she ends up paying two layers of fees: one for the FoF itself and one for the underlying funds. This double-charging can eat into final returns.
 

Let’s break down where the costs come from when you invest in a fund of funds.Being aware of these layered costs helps Kriti make informed decisions without getting caught by surprise.

Example: If the total annual fees on Kriti’s ₹1,00,000 investment are 2.5%, she will lose ₹2,500 each year to costs. If she invested in a direct fund (fee 1.5%), only ₹1,500 would be deducted annually.

Kriti’s Portfolio, One Year Later

After a year, Kriti checks her returns to see if the FoF benefited her. Her portfolio is made up of equities, gold, debt, and global funds, all performing differently.

Here’s a snapshot of how Kriti’s FoF allocation looks after one year.
 

Kriti’s risk was balanced and her returns steady, even though not every investment type outperformed.

Example: From ₹1,00,000, Kriti’s portfolio grows to ₹1,08,600 before fees. After deducting 2.5% costs (₹2,500), she gets a neat ₹1,06,100. Her journey is smooth

Conclusion

A fund of funds is a smart, low-effort way for investors like Kriti to get instant diversification and professional management. While convenience is high, costs can be higher than single funds, and overlapping investments may blunt some benefits. The key is to match FoF features to your own goals, understand fees, and choose wisely for steady wealth building.

FAQs 
 

Can I switch my Fund of Funds anytime without extra cost?

Many FoFs charge an exit load if you withdraw early. Always read the terms for lock-in and exit loads.

How are capital gains from FoFs taxed compared to regular mutual funds?

Some FoFs may be taxed as debt funds, even if they invest in equity, which can impact short- and long-term tax rates. Confirm with a tax professional before investing.

Can FoF underperform its best component fund?

Yes, due to higher fees and overlapping holdings, an FoF’s overall return might sometimes be lower than the top-performing fund within it.

Will I receive dividends paid out by the underlying funds?

No, FoF investors generally receive returns in the form of growth in NAV; underlying dividends are usually reinvested.

What are alternatives to a fund of funds if I want diversification?

You could create a customised mix of varied mutual funds or pick balanced hybrid/index funds, however, you’ll have to manage rebalancing and monitoring on your own.

Do FoFs always protect from losses in market crashes?

While FoFs spread out risk, it does not guarantee against losses. If all underlying markets or assets fall, the FoF value can decline too.

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About the Author

LoansJagat Team

‘Simplify Finance for Everyone.’ This is the common goal of our team, as we try to explain any topic with relatable examples. From personal to business finance, managing EMIs to becoming debt-free, we do extensive research on each and every parameter, so you don’t have to. Scroll up and have a look at what 15+ years of experience in the BFSI sector looks like.