Is It Better to Have Multiple Mutual Funds? Finding the Right Balance for Your Portfolio

Have you ever stared at your investment account wondering if you’ve got too many mutual funds or not enough? I’ve been there! The question of whether it’s better to have multiple mutual funds is something that puzzles many investors from newbies to seasoned pros.

The truth is, there’s no one-size-fits-all answer, but there are some guiding principles that can help you make sense of your portfolio. Let’s dive into the world of mutual fund diversification and find out if more really is better.

The Diversification Debate: How Many Funds Do You Really Need?

When it comes to stocks, financial experts generally agree that a well-balanced portfolio contains about 20-30 stocks to diversify away the maximum amount of unsystematic risk. But here’s where things get interesting – a single mutual fund often contains five times that number of stocks!

So does that mean one fund is enough? Well, opinions are split.

The “One Fund is Enough” Camp

Some investment experts suggest that equity investors need just one broad index fund, such as the Vanguard Total Stock Market Index Fund. The idea is simple – buy a comprehensive index fund and let time work its magic.

Even investors looking for both stocks and bonds can achieve their desired asset allocation through a single balanced fund Talk about keeping things simple!

The “You Need More” Camp

Others argue that a single fund fails to provide adequate exposure to international investments. Their reasoning goes something like this:

• A global fund gives you a little bit of everything, but not enough of anything
• A better approach might be:
  • A large-cap domestic fund
  • A small-cap domestic fund
  • An international fund (or two) covering developed foreign markets like Europe
  • Another international fund for emerging markets (Pacific Rim, Latin America)
  • A domestic bond fund if fixed income exposure is desired

That brings the total to about six funds. Not overwhelming, but definitely more than one!

Understanding the Style Box Approach

The traditional mutual fund style box consists of nine investment categories for domestic equities, based on:

• Market capitalization (micro, small, mid, large)
• Investment style (value, mixed, growth)

Similarly, the bond style box has:

• Three maturity categories (short-term, intermediate, long-term)
• Three credit quality categories (high, medium, low)

But here’s the thing – you don’t need a fund in every single category! A few carefully chosen funds that match your asset allocation goals and risk tolerance can do the trick.

When Diversification Backfires: Too Much of a Good Thing

Mutual funds are popular because they provide exposure to many stocks in one convenient package. But too much of a good thing can actually be counterproductive!

Adding too many funds can accidentally create what I like to call an “expensive index fund.” This happens when:

1. Too many funds negate the impact any single fund can have on performance
2. The expense ratios of multiple funds add up to a higher-than-average total
3. The end result? Higher costs with mediocre performance

In my experience working with clients, I’ve seen portfolios with 15+ mutual funds that essentially track the market but cost way more in fees than a simple index fund would. Not smart!

There’s No Magic Number (But It’s Probably Not 20!)

Despite the thousands of mutual funds available from hundreds of providers, there’s no magical “right” number. However, almost everyone agrees you don’t need dozens of funds.

In fact, many mutual fund companies now promote life-cycle funds (also called age-based or target-date funds). These are essentially funds-of-funds – one fund that invests in multiple underlying funds. The concept? Pick one life-cycle fund, invest everything in it, and don’t worry about it until retirement.

I’ve got to admit, there’s an appealing simplicity to that approach!

How to Build Your Own Mutual Fund Portfolio Without Overdoing It

If you prefer to construct your own portfolio rather than going with an all-in-one solution, here are some steps to keep your fund count reasonable:

1. Start With Your Objectives

• If income is your primary goal, you might not need that international fund
• If capital preservation is your focus, maybe skip the small-cap fund
• Your specific goals should determine which categories are necessary

2. Check for Overlapping Holdings

This is super important! Compare the underlying holdings of funds you’re considering. If two or more funds have significant overlap in the stocks they hold, eliminate the duplicates. There’s literally no point in owning multiple funds that contain the same stocks.

3. Compare Expense Ratios

When two funds have similar holdings, go with the cheaper one. Every penny saved on fees is more money working for you. I’ve seen cases where investors were paying triple the fees for essentially the same exposure!

4. Consolidate Small Positions

If you’re working with an existing portfolio rather than starting fresh, look at eliminating funds with balances too small to impact overall performance. Got three large-cap funds? Consider moving all that money to a single fund. Your diversification level stays the same, but your expenses likely go down.

Real-World Fund Combinations That Work

Let me share some practical examples of fund combinations that can provide excellent diversification without going overboard:

The Core Four (4 funds)

• A total US stock market index fund (40-60%)
• An international stock index fund (20-40%)
• A US bond index fund (10-30%)
• A small allocation to a REIT fund (5-10%)

The Simple Three (3 funds)

• A target-date retirement fund (80-90%)
• A specialized fund in an area of interest (5-10%)
• A money market fund for emergency cash (5-10%)

The Minimalist (2 funds)

• A global balanced fund (80-90%)
• A money market fund (10-20%)

Each of these approaches can work well depending on your specific situation. The key is intentionality – each fund should serve a distinct purpose in your portfolio.

When More Funds Might Actually Make Sense

While I’ve been harping on about keeping your fund count low, there are legitimate reasons to own multiple funds:

1. Tax management – Different accounts (taxable vs. retirement) might need different fund types for tax efficiency

2. Access to specialized markets – If you want exposure to specific sectors or countries not covered by broad index funds

3. Different time horizons – Having separate funds for short-term, medium-term, and long-term goals

4. Core and explore strategy – Using index funds for the bulk of your portfolio while adding a few actively managed funds in areas where you believe active management can outperform

Just make sure each additional fund serves a specific purpose that isn’t already covered by your existing holdings.

Signs You Definitely Have Too Many Funds

How do you know if you’ve gone overboard? Here are some telltale signs:

• You can’t name all your funds without looking at your statements
• Your portfolio performance closely tracks the market but with higher fees
• Multiple funds show the same top 10 holdings
• You have funds you haven’t reviewed in years
• Your quarterly statements resemble a small phone book

If any of these sound familiar, it might be time for some spring cleaning in your portfolio!

The Bottom Line: Quality Over Quantity

When it comes to mutual funds, it’s definitely a case of quality over quantity. Most investors can achieve excellent diversification with somewhere between 3 and 8 well-chosen funds.

Remember these key points:

• Each fund should serve a specific purpose in your portfolio
• Avoid overlap between funds
• Keep an eye on total expenses
• Regularly review your holdings to ensure they still match your goals

The goal isn’t to own as many funds as possible – it’s to build a portfolio that helps you reach your financial objectives with an appropriate level of risk and reasonable costs.

So, is it better to have multiple mutual funds? Yes, but with an important caveat – only if each fund plays a distinct and necessary role in your investment strategy. Otherwise, you might be better off streamlining your portfolio and focusing on a smaller number of high-quality funds that truly diversify your investments.

What’s your approach? Do you prefer the simplicity of fewer funds or the potential benefits of more specialized holdings? Whatever you choose, make sure it’s an intentional decision rather than a haphazard collection of investments that once seemed like good ideas!