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
Unless you are very well versed with the markets and have expert knowledge about mutual funds, a good rule of thumb would be to own: Large Cap Mutual Funds: Up to 2. 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.
Is it good to have many mutual funds? ›
Most of the debt mutual funds provide similar returns, so it is not practical to have multiple debt mutual funds. Small-Cap Mutual Funds: It's better to invest in only two small-cap mutual funds since the risk is too high. As such, one must limit themselves to a small number of these mutual funds.
What if I invest $10,000 every month in mutual funds? ›
How much Return Rs.10000 would create in 30 Years? If you invest Rs.10000 per month through SIP for 30 years at an annual expected rate of return of 11%, then you will receive Rs.2,83,02,278 at maturity.
How to reduce the number of mutual funds in a 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.
How much will I get if I invest $50,000 in mutual funds? ›
Mutual Fund Calculator
| Total Invested | Gains | Future value |
|---|
| ₹50,000 | ₹38,117 | ₹88,118 |
We're talking about the usual suspects here: stocks (and a wide variety of stock types), bonds, and alternative investments such as gold. A commonly cited rule of thumb is to own between 10 and 20 mutual funds, but the actual number will vary depending on your individual circ*mstances.
What is the ideal number of mutual funds in a portfolio? ›
Diversification ensures you get the best returns, or so goes common advice. Rohin Pagdiwala, CFP and founder of Pagdiwala Investments, said a portfolio can achieve sufficient diversification with 7-10 funds. Asset allocation should determine the selection of funds, he said.
What are three disadvantages of mutual funds? ›
Disadvantages include high fees, tax inefficiency, poor trade execution, and the potential for management abuses.
How much money should you keep in mutual funds? ›
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 8 4 3 rule in mutual funds? ›
Let's take a look at how the 8-4-3 rule works: For example, if we invest Rs 21250 every month at an annual interest rate of 12% for the next 15 years, we will accumulate Rs 1 crore by the end of the period! Rs 21,250 invested every month for the first 8 years, will lead to a corpus of Rs 34.3 lakhs.
How the Rule of 72 Works. For example, the Rule of 72 states that $1 invested at an annual fixed interest rate of 10% would take 7.2 years ((72 ÷ 10) = 7.2) to grow to $2. In reality, a 10% investment will take 7.3 years to double (1.107.3 = 2). The Rule of 72 is reasonably accurate for low rates of return.
What if I invest $1,000 a month in mutual funds for 20 years? ›
Mid Cap Mutual Fund:- If you invest Rs 1000/per month for 20 yrs in Mid cap mutual fund, Assuming that 15–16 % interest rate. You will have approx 15–16 lakhs.In long term all mutual funds are safe.
Why are all my mutual funds losing money? ›
Losses in mutual funds are expected as it depends on market conditions, but redeeming in haste can bring the losses in reality. Some reasons for losses in mutual funds are lack of knowledge, unrealistic expectations, etc.
How to declutter a mutual fund portfolio? ›
Evaluate Performance: Regularly assess each fund's long-term performance against its category average and benchmark. Exit Underperformers: Don't be afraid to exit funds that consistently underperform. Focus on Impact: Remove investments that don't contribute significantly to your overall portfolio goals.
Why is my portfolio losing so much money? ›
It's also possible that you're not diversified enough. If you have all of your investments in one type of asset—like stocks or bonds—you could be taking on more risk than necessary. Instead, consider diversifying your holdings among various types of assets so that if one goes down, others will hold up better.
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.
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? ›
Mutual fund investments when used right can lead to good returns, keeping risk at a minimum, especially when compared with individual stocks or bonds. These are especially great for people who are not experts in stock market dynamics as these are run by experienced fund managers.
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.
