In one form or another I’ve been asked by several readers “… do I own too many mutual funds?” In several cases the question was prompted by the number of mutual fund holdings in brokerage accounts with major brokerage firms including brokerage wrap accounts. One reader cited an account with $1.5 million and 35 mutual funds.
So how many mutual funds are too many? There is not a single right answer but let’s try to help you determine the best answer for your situation.
The 3 mutual fund portfolio
I would contend that a portfolio consisting of three mutual funds or ETFs could be well-diversified. For example a portfolio consisting of the Vanguard Total Stock Market Index (VTSMX), the Vanguard Total International Stock Index (VGTSX) and the Vanguard Total Bond Index (VBMFX) would provide an investor with exposure to the U.S. stock and bond markets as well as non-U.S. developed and emerging markets equities.
As index funds the expenses are low and each fund will stay true to its investment style. This portfolio could be replicated with lower cost share classes at Vanguard or Fidelity if you meet the minimum investment levels. A very similar portfolio could also be constructed with ETFs as well.
This isn’t to say that three index funds or ETFs is the right number. There may be some additional asset classes that are appropriate for your situation and certainly well-chosen actively managed mutual funds can be a fit as well.
19 mutual funds and little diversification
A number of years ago a client engaged my services to review their portfolio. The client was certain that their portfolio was well-diversified as he held several individual stocks and 19 mutual funds.
After the review, I pointed out that there were several stocks that were among the top five holdings in all 19 funds and the level of stock overlap was quite heavy. These 19 mutual funds all held similar stocks and had the same investment objective. While this client held a number of different mutual funds he certainly was not diversified. This one-time engagement ended just prior to the Dot Com market decline that began in 2000, assuming that his portfolio stayed as it was I suspect he suffered substantial losses during that market decline.
How many mutual funds can you monitor?
Can you effectively monitor 20, 30 or more mutual fund holdings? Frankly this is a chore for financial professionals with all of the right tools. As an individual investor is this something that you want to tackle? Is this a good use of your time? Will all of these extra funds add any value to your portfolio?
What is the motivation for your broker?
If you are investing via a brokerage firm or any financial advisor who suggests what seems like an excessive number of mutual funds for your account you should ask them what is behind these recommendations. Do they earn compensation via the mutual funds they suggest for your portfolio? Their firm might have a revenue-generating agreement with certain fund companies. Additionally the rep might be required to use many of the proprietary mutual funds offered by his or her employer.
Circumstances will vary
If you have an IRA, a taxable brokerage account and a 401(k) it’s easy to accumulate a sizable collection of mutual funds. Add in additional accounts for your spouse and the number of mutual funds can get even larger.
The point here is to keep the number of funds reasonable and manageable. Your choices in your employer’s retirement plan are beyond your control and you may not be able to sync them up with your core portfolio held outside of the plan.
Additionally this is a good reason to stay on top of old 401(k) plans and consolidate them into an IRA or a new employer’s plan when possible.
The Bottom Line
Mutual funds remain the investment of choice for many investors. It is possible to construct a diversified portfolio using just a few mutual funds or ETFs.
Holding too many mutual funds can make it difficult to monitor and evaluate your funds as well as your overall portfolio.
Approaching retirement and want another opinion on where you stand? Not sure if your investments are right for your situation? Concerned about stock market volatility? Check out my Financial Review/Second Opinion for Individuals service for detailed guidance and advice about your situation.
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