The consensus is that a well-balanced portfolio with approximately 20 to 30 stocks diversifies away the maximum amount of unsystematic risk. Because a single mutual fund often contains five times that number of stocks, does that mean that one fund is enough?
Vote "Yes"
Proponents of the "Yes" theory suggest that equity investors buy a broad index fund, such as the Vanguard Total Stock Market Index Fund, and let time do its work. Even investors seeking exposure to both stocks and bonds can get their desired asset allocation through the purchase of a single balanced fund.
Vote "No"
On the equity side, others would note that a single fund would fail to provide adequate exposure to international investments. The argument here is that a global fund provides a little bit of everything, but not enough of anything. From there, the argument goes that a large-cap domestic fund and a small-cap domestic fund cover the bases on the home front. An international fund, perhaps two at most, cover the international front. Two-fund proponents select one fund from the developed foreign markets, like Europe, and the second in emerging markets such as the Pacific Rim or Latin America. If fixed-income exposure is desired, a domestic bond fund is added to the mix, bringing the count to six funds.
What About the Style Box?
The traditional mutual-fund style box consists of nine investment categories representing domestic equities. Those categories are based on market capitalization (micro, small, mid, large, etc.) and investment style (value, mixed, growth). The bond style box, in similar fashion, has three maturity categories (short-term, intermediate, and long-term) and three categories of credit quality (high, medium,and low). An investor does not need a fund in all the stock and bond categories. A few funds can be chosen that best fit an investor's asset-allocation and risk-return requirements.
The Downside of Diversification
While mutual funds are popular and attractive investments because they provide exposure to a number of stocks in a single investment vehicle, too much of a good thing can be a bad idea.
The addition of too manyfunds simply creates an expensive index fund. This notion is based on the fact that having too many funds negates the impact that any single fund can have on performance, while the expense ratios of multiple funds generally add up to a number that is greater than average. The end result is that expense ratios rise while performance is often mediocre.
No Magic Number
Although there are hundreds of mutual fund providers offering thousands of funds, there's no magical "right" number of mutual funds for your portfolio. Despite the lack of agreement among the professionals regarding how many funds are enough, nearly everyone agrees that there is no need for dozens of holdings. In fact, even many mutual fund companies are now promoting life-cycle funds, which consist of a mutual fund that invests in multiple underlying funds The concept is simple: Pick one life-cycle fund, put all of your money into itand forget about it until your reach retirement age. These funds, also referred to as "age-based funds" or "target-date funds," have an intrinsic appeal that's hard to beat.
Building Your Own Mutual-Fund Portfolio
If you prefer to build a portfolio rather than buy an all-in-one solution, there are simple steps you can take to limit the number of funds in your portfolio while still feeling comfortable with your holdings. It begins by considering your objectives. If income is your primary goal, that international fund may not be necessary. If capital preservation is your objective, a small-cap fund may not be needed.
Once you've determined the mix of funds that you wish to consider, compare their underlying holdings. If two or more funds have significant overlap in holdings, some of those funds can be eliminated. There's simply no point in having multiple funds that hold the same underlying stocks.
Next, look at the expense ratios. When two funds have similar holdings, go with the less expensive choice and eliminate the other fund. Every penny saved on fees is one more penny working for you. If you are working with an existing portfolio rather than building one from scratch, eliminate funds that have balances that are too small to make an impact on overall portfolio performance. If you've got three large-cap funds, move the money to a single fund. The amount spent on management-related expenses is likely to decrease and your level of diversification will remain the same.
FAQs
Maybe 3 at best. Beyond that, it doesn't make sense as there will be a great overlap in the shares owned by your mutual funds. Mid Cap Mutual Funds: Up to 2. While you might get higher returns, the risk you expose yourself to is also higher.
How do I reduce the number of mutual funds in my portfolio? ›
How to reduce the number of mutual funds in the portfolio? Remove any fund whose exposure is less than 5% of the portfolio. If a fund is less than 5 per cent of the portfolio (equity funds) and you are not even adding to the fund, you must exit such fund.
Is it good to have many mutual funds? ›
If you have a particular strategy or want diversification within your portfolio, then investing in multiple mutual funds can be a good idea. Diversification implies spreading your investments across different asset classes, industries, and geographical regions to reduce your overall risk.
How many number of mutual funds should I have? ›
There's no fixed rule about the number of mutual funds that an investor should invest in. However, the thumb rule is to have a diversified portfolio with 4 to 5 different types of funds. A diversified fund portfolio typically has exposure to equity, debt, gold, different sectors and global markets.
Is 5 mutual funds too much? ›
The Downside of Diversification
While mutual funds are popular and attractive investments because they provide exposure to a number of stocks in a single investment vehicle, too much of a good thing can be a bad idea. The addition of too many funds simply creates an expensive index fund.
How many mutual funds should I have in my 401k? ›
How Many Mutual Funds You Should Hold. There's no magic number of funds to keep in a 401(k) or another portfolio for long-term investing. The right number of investments is one that ensures diversification but also factors in your investment approach. If you prefer low-effort investing, consider buying a single fund.
What percentage of your portfolio should be in mutual funds? ›
A widely accepted guideline is the 50/30/20 rule. Allocate 50% of your income to necessities, 30% to discretionary spending, and reserve 20% for savings and investments. Within this 20%, your mutual fund allocation can be further optimised based on your risk tolerance and investment goals.
What is the ideal number of funds in a portfolio? ›
Understanding the Ideal Number of Stocks to Own
The more equities you hold in your portfolio, the lower your unsystematic risk exposure. A portfolio of 10 or more stocks, particularly across various sectors or industries, is much less risky than a portfolio of only two stocks.
What is the 4 fund strategy? ›
The Four Fund Combo is built on four index funds (or exchange-traded funds) that include the most basic U.S. equity asset classes: large-cap blend stocks (the S&P 500 SPX, +0.27%, in other words), large-cap value stocks, small-cap blend stocks, and small-cap value stocks.
What are three disadvantages of mutual funds? ›
Disadvantages include high fees, tax inefficiency, poor trade execution, and the potential for management abuses.
To determine how much to invest in Mutual Funds monthly, subtract your monthly expenses including contributions to your emergency fund and short-term goals from your monthly income. The remainder is what you can allocate to investments.
What is the best mutual fund to invest in in 2024? ›
Best-performing U.S. equity mutual funds
Ticker | Name | 5-Year Return (%) |
---|
USNQX | Victory NASDAQ-100 Index | 21.1 |
VIGRX | Vanguard Growth Index Investor | 18.61 |
NWJFX | Nationwide NYSE Arca Tech 100 Idx InsSvc | 16.13 |
VQNPX | Vanguard Growth & Income Inv | 15.08 |
4 more rowsJul 2, 2024
What is the 80% rule for mutual funds? ›
The current names rule generally requires that if a fund's name suggests a focus in a particular type of investment, or in investments in a particular industry or geographic focus, the fund must adopt a policy to invest at least 80% of the value of its assets in the type of investment, or in investments in the industry ...
What is the 3 5 10 rule for mutual funds? ›
Specifically, a fund is prohibited from: acquiring more than 3% of a registered investment company's shares (the “3% Limit”); investing more than 5% of its assets in a single registered investment company (the “5% Limit”); or. investing more than 10% of its assets in registered investment companies (the “10% Limit”).
What is the 4% rule for mutual funds? ›
The 4% rule says people should withdraw 4% of their retirement funds in the first year after retiring and take that dollar amount, adjusted for inflation, every year after. The rule seeks to establish a steady and safe income stream that will meet a retiree's current and future financial needs.
How much overlapping in mutual funds is acceptable? ›
While there's no fixed rule, a lower overlap is better for diversification. Aim to keep it below 33% for a balanced portfolio. To reduce overlap: Diversify across fund categories systematically: Investing in funds from different categories won't guarantee low overlap unless chosen strategically.
Is it safe to put all money in mutual funds? ›
Are mutual fund investments safe? Market-linked mutual funds are subject to market risk that can be caused by several reasons such as changes in policy, macroeconomic conditions, pandemics, poor investor confidence and so on. Therefore it is a good idea to go through document papers carefully before investing.
What should be the ideal mutual fund portfolio? ›
An ideal mutual fund portfolio is one that suits your goals and risk-taking capacity. It must also have a maximum of 6-7 funds to ensure adequate diversification.
Is there a limit to invest in mutual funds? ›
The mutual fund industry does not have a specific limit, but it is regulated by governing bodies to ensure investor protection and market stability. The industry's size may fluctuate based on market conditions, investor demand, and regulatory changes.