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Mutual Fund Overdose!

I came across an article today about a woman who owned 84 mutual funds. So what, you might say? Well, having too many mutual funds can lead to several problems:

  • Time crunch – difficulty finding the time to stay up on developments that could negatively impact your portfolio performance such as a fund manager retirement
    Increased risk - due to overweighting in a particular stock owned by several different mutual funds
  • Diluted returns – if you have too many mutual funds, you could see the returns canceled by the losses in a one-to-one ratio such that your portfolio performance goes nowhere. How many mutual funds should you own to achieve effective diversification? The answer to this question varies depending upon your investment goals but you can use a standard rule of thumb to help make this decision.

The Asset Classes
Investors can choose from 15 different asset classes to include in their portfolio. In light of this, your portfolio should have no more than 11-13 mutual funds. You can further reduce that number in several ways:

  • Balanced asset allocation funds – also known as hybrid funds, the balanced fund invests in a mix of domestic stocks, bonds and cash within one fund
  • Blended fund – invests in domestic stocks of various sizes (large-, mid-, and small-cap) and mixed characteristics (value and growth) within one fund; typically you will find blended funds that focus on large/mid-caps and separate funds that focus on small-caps
  • Index funds – using index funds would allow you to have as few as 4 mutual funds: one fund representing the entire US stock market (i.e., Wilshire 5000 Index), one fund covering the international stock market (i.e., tracking the Total International Composite Index), one fund investing in the total domestic bond market (i.e., Lehman Aggregate Bond Index) and one money market fund

If you have more than 13 mutual funds, start paring back. Morningstar has some excellent tools to help you with this task. Check out their Portfolio Allocator and Instant X-ray.

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