Mutual funds are a favorite among investors because they provide an easy means of investing in a variety of stocks, bonds, or other investments. Mutual funds allow you to own a diversified group of holdings without selecting individual investments yourself, since they collect money from numerous investors and pool it together.
But the question is, how many mutual funds do you need to hold? Your response will be based on your investment objectives, the level of risk you can afford, and the period of time you can devote to monitoring your investments. In this blog article, we’ll demystify the considerations that go into making this decision, offer expert insights, and present examples of various portfolio configurations. Whether a first-time investor or a seasoned one, this primer will assist you in striking the proper balance for your mutual fund portfolio.
1. Understanding Diversification
Diversification is a key idea in investing. It means spreading your money across different types of investments to lower your risk. If one investment does poorly, others might do well, helping to protect your overall portfolio. Mutual funds are already diversified because they hold many different assets, like stocks or bonds. But a single fund may not be sufficient if it concentrates on one niche, such as technology stocks or American bonds. For instance, if you hold only a tech stock fund and the tech industry collapses, your portfolio will suffer heavily.
To diversify more, you may need funds spanning different asset classes (such as stocks and bonds) and geographical locations (such as U.S. and international markets). The amount of funds you require varies with the level of diversification you desire and how complex you are willing to keep your portfolio. A combination of 3 to 5 funds may be sufficient for most investors in order to obtain adequate diversification without excessive complexity. Find out more on diversification.
2. Factors Influencing the Number of Mutual Funds
There are a few factors that will help you determine how many mutual funds you should own:
- Investment Goals: Your objectives define your portfolio. If you are trying to save for a short-term objective, such as buying a car in the next few years, you may prefer fewer, lower-risk funds, like bond funds. For longer-term objectives, such as retirement, you may prefer more higher-growth funds, like stock funds, to spread risk across markets.
- Risk Tolerance: How much risk can you tolerate? If you’re conservative, you may like to have a few stable funds, such as bond or balanced funds. If you’re not conservative, you could include more stock funds or sector funds to increase potential returns.
- Time and Effort: Having more than one fund requires effort. You must monitor their performance, learn about their strategy, and rebalance your portfolio to keep your desired asset allocation. If you don’t have time or want a low-maintenance option, fewer funds or an all-in-one fund may be a better choice.
- Investment Costs: All mutual funds come with fees, such as an expense ratio, which is a share of your investment that’s taken out every year. For instance, actively managed funds may take 1% or more, while index funds take less than 0.2%. Having too many funds can boost your overall fees, eating into your returns. It is important to balance diversification with fees.
These factors are personal, so what works for one investor might not work for another.
3. Expert Recommendations
Most financial experts recommend that few investors require a multitude of mutual funds to create a solid portfolio. A typical recommendation is to have 3 to 5 funds that have different asset classes. For Example, you may have:
- A U.S. large-cap stock fund (like an S&P 500 index fund)
- An international stock fund
- A bond fund
This arrangement gives exposure to home markets and overseas markets with the addition of safe securities such as bonds. Other advisors recommend adding a small-cap stock fund or a real estate fund as an additional diversifier. Alternatively, if you prefer a still simpler strategy, try an all-in-one fund, such as a target-date fund, which changes its blend of stocks and bonds automatically in relation to your retirement date. These funds are ideal for those investors looking for diversification without having to handle several funds. The trick is to have your portfolio simple enough to handle but diversified enough to help minimize risk. Specialists caution against having too many funds, as this may cause redundant investments and more expenses without contributing significant diversification. Read expert advice on building your portfolio.
4. Portfolio Examples
Here are three common portfolio structures to show how the number of funds can vary:
- 3-Fund Portfolio:
- Funds: U.S. large-cap stock fund, international stock fund, bond fund
- Pros: Simple to manage, covers major asset classes, low costs if using index funds
- Cons: Limited exposure to smaller markets, like small-cap stocks or real estate
- 5-Fund Portfolio:
- Funds: U.S. large-cap stock fund, U.S. small-cap stock fund, international stock fund, bond fund, real estate fund
- Pros: High diversification, exposure to more market segments
- Cons: More complex to manage, potentially higher fees
- All-in-One Fund:
- Fund: Target-date fund or balanced fund
- Pros: Automatic diversification and rebalancing, minimal effort required
- Cons: Less control over asset allocation, may not perfectly match your goals
Each choice is best for a different category of investors. A 3-fund portfolio is best for new investors, while a 5-fund portfolio could suit those who desire more market representation. Target-date funds are best for hands-off investors. Educate yourself about target-date funds.
Comparison Table
Here’s a table comparing the portfolio options:
| Portfolio Type | Number of Funds | Diversification Level | Management Complexity | Potential Returns |
|---|---|---|---|---|
| 3-Fund | 3 | Moderate | Low | Moderate |
| 5-Fund | 5 | High | Moderate | High |
| All-in-One | 1 | High | Very Low | Varies |
Conclusion
Determining how many mutual funds to invest in is a matter of personal preference based on your investment goals, risk tolerance, and the amount of time you can commit to overseeing your investments. Studies indicate that 3 to 5 solidly selected mutual funds will be sufficient diversification for most people and still be easy to manage. If you want simplicity, an all-in-one fund such as a target-date fund may be the easiest choice.
Checking your portfolio regularly—once a year, for example—will help keep it up to speed with your needs. Balancing diversification, simplicity, and expense, you can create a portfolio that serves you. If you’re still unsure, think about getting advice from a financial advisor. Locate a financial advisor.
FAQ: How Many Mutual Funds Should I Own?
- What is the ideal number of mutual funds to own?
There’s no perfect number, but experts often recommend 3 to 5 mutual funds for a diversified portfolio that’s easy to manage. - Can I own too many mutual funds?
Yes, owning too many funds can lead to overlapping investments, higher fees, and more time spent managing your portfolio. - How do I know if my mutual funds are diversified enough?
Check if your funds cover different asset classes (stocks, bonds, etc.) and regions (U.S., international). Avoid funds with similar holdings to prevent overlap. - Should I consider index funds instead of actively managed funds?
Index funds often have lower fees and provide broad market exposure, making them a great choice for many investors. Actively managed funds may be worth considering if you believe the manager can outperform the market. - Do I need to rebalance my mutual fund portfolio?
Yes, rebalancing once a year or when your asset allocation drifts significantly helps maintain your desired risk level and investment goals.
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