How many funds do you need?

Diversifying your mutual-fund portfolio cuts the risk of giving all your money to one manager who has one way of seeing the market. But how many funds do you need?

If you’re wondering how many mutual funds make a well-diversified portfolio, chances are you hold a lot of them. There are several drawbacks to holding a large number of funds. They may simply be difficult for you to keep track of, or they may result in a portfolio with excessive expense levels. But most important, a portfolio with a large number of mutual funds may well suffer from a limited performance.

If you only invest in mutual funds, we always recommend you start with a portfolio of two or three conservative Canadian equity funds, such as those on our Facts and Advice page or the Mutual Fund Planning Guide we periodically publish. These provide plenty of diversification by investment style, and give you a solid core bulk of your equity investments in low-risk funds. They create confidence that equities are worthwhile investments, and protect you from sudden losses that higher-risk or specialty funds are more apt to suffer.

Protect yourself from problems at home

Whether you’re just a mutual-fund investor, or you invest in other equity securities we recommend in Money Reporter, we recommend you diversify internationally as well. You should start with conservative funds like Capital Group Global Equity or RBC Global Dividend Growth. These provide a conservative style, but also protection from economic or other problems that may be peculiar to Canada.

Beyond these basics, you may wish to add some of the opportunity available in specially focused funds. These include funds that specialize in various industries such as healthcare, technology, resources, or other specific industries. They also include funds that specialize in geographical regions such as Dynamic Asia Pacific or Invesco Europlus.

Weed and feed

As you diversify, however, it can be all too easy to find yourself holding dozens of different funds, especially if you don’t weed out the poor performers as you go along.

Holding too many funds can give you a total portfolio that’s much like an index fund. You’ll simply own most of the stock available in one fund or another. But you won’t enjoy the low fees most index funds offer. You also won’t perform much better than average, since the more funds you own, the more likely it becomes that you’ll have a balance of over-performing and under-performing funds.

Similar funds hold similar stocks

Another problem you’ll experience in holding a large number of funds lies in duplication, especially among funds with similar investment objectives. Take large-cap Canadian equity funds, for example. Since these funds must stick mainly to the same types of stocks, you’ll find a large number of securities common to many of them. The five big banks, BCE Inc. and major Canadian energy and railway companies come instantly to mind.

We strongly suggest that every time you’re tempted to add a little of some trendy new fund to your portfolio, consider instead adding a little more to your diversified fund that may be invested in those same securities. For instance, RBC Emerging Markets Equity Fund may already hold some of the choice investment opportunities in emerging markets that investors get when they focus on a Chinese or Indian fund.

We think few investors need more than a half dozen funds to meet their needs (fewer if you already invest directly in Canadian stocks). We certainly can’t imagine a good reason to hold more than 12.

This is an edited version of an article that was originally published for subscribers in the November 15, 2019, issue of Money Reporter. You can profit from the award-winning advice subscribers receive regularly in Money Reporter.

Money Reporter, MPL Communications Inc.
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