Do you know how many mutual funds you should hold in your portfolio? The real answer is probably far different from what you think. But don’t worry. By the time you finish reading this post, you’ll have your answer.
First Things First
First, remember that your financial goals determine your investment strategy. And your strategy dictates which funds and how many you should have in your portfolio. For example, if you are a buy and hold investor you would probably want 7 to 10 funds in your portfolio. That list might include:
- Large Cap Growth
- Large Cap Value
- Mid Cap Growth
- Mid Cap Value
- Small Cap Growth
- Small Cap Value
- Emerging Markets
- Real Estate
You could grow this list easily by expanding the international holdings by capitalization and by growth and value. But these are the 10 asset classes that people normally hold if you are an asset allocator and buy and holder. And while you could have more than one mutual fund in each of these asset classes, you probably don’t need to do so. Over time, it won’t make much difference which fund you select within each category assuming you use ETFs or index funds (as you probably should in a buy and hold approach).
Why not use one fund that combines all these different asset classes?
Some people buy just one fund – like a S&P 500 index fund – and that’s it. The problem with this approach is that such a portfolio doesn’t have much diversification. As a result (at least theoretically) these investors are taking on more risk.
To be frank, my experience tells me that when things get bad almost everything goes down the drain. So diversification may not help shield you from the downsides as much as you think.
The real problem with only using one fund is that such an approach forgoes opportunity. In other words, there will be times when one asset class does far better than others. If you don’t have any money invested in that area you basically kiss that opportunity goodbye.
What about using one fund that provides exposure to all the different asset classes?
You could go that route of course but I don’t recommend it. You benefit by having a different fund in each category. When you do so it’s easy to see what is and what isn’t working. When everything is mashed together in one giant fund it’s very difficult to see what’s really going on within the portfolio.
When you have different funds in each asset class, it’s very easy to verify that each component of your portfolio is keeping up with the indexes. If you have one conglomerate fund, that kind of tracking is just impossible.
What if you aren’t a buy and hold investor?
Long time readers of Wealth Pilgrim know that I don’t take the buy and hold approach to investing. If you share my preference to be a bit more proactive, you probably don’t need 10 funds like the buy and hold investor. Again, this depends on the strategy you use.
The approach I utilize tries to identify the top 4 to 6 funds out of a large universe of funds and ETFs. I typically invest in just those top funds. I reevaluate the performance on a monthly basis so if one fund falls out of favor, it’s replaced. If all those top funds are in large cap growth, so be it. If the top funds are a diversified bunch, that’s fine too.
This is very different from buy and hold and it has its pros and cons. The purpose of this post is not to argue which investment approach is best. The purpose here is to illustrate that your strategy will determine the number of funds to own.
What if your account size is small?
If your account is small, you may have to limit the number of funds you use. That’s because most mutual funds have minimum investments of at least $500. So if you only have $1000 to invest, you won’t be able to buy more than 2 funds. If you are in this situation, I suggest you go one of three ways.
First, if you are willing to be a bit more aggressive, you could concentrate your investments in one or two funds that seem like strong performers. Of course you’ll have to keep your eyes on these funds and rebalance from time to time but this could be a great way to learn as you invest.
If you don’t want to be so involved in the investment process, you might select a broad-based ETF like the S&P 500 and just plop your money into that. You give up some of the upside of being diversified but you have little choice.
A third suggestion is to use a service like Betterment. They have low minimums and they will rebalance your account as needed. It’s a great turn-key service for people with limited investment dollars who also want to learn as they invest.
As you can see, before you decide how many funds to hold in your portfolio, think about how you want to invest and what your objectives are. Also, think about how actively involved you want to be in the process. If you want a hands-off approach and are happy with the buy and hold system, you’ll probably want 10 funds. If you are willing to be a bit more active, you can get away with far fewer funds but you’ll have to keep your eye on the holdings and reevaluate your positions from time to time.
How many funds are in your portfolio? How do you decide how many funds to hold?