Every investment advisor asks you to diversify your investments to safeguard them from sudden risks. But do you know you can overdo it?
Have you ever stood in front of the ice cream counter, overwhelmed by choices? Too many flavors can make a simple decision paralyzing. The same thing happens with mutual funds – too few and you’re not protected; too many and you’re just creating a mess. So how many mutual funds should one person actually have in their portfolio?
I’ve been helping folks navigate this question for years, and today I’m gonna break it down in simple terms.
Why “More” Isn’t Always “Better” in Mutual Fund Investing
You’ve probably heard about diversification – it’s basically the investing version of “don’t put all your eggs in one basket” Every financial advisor will tell you to diversify, But here’s the thing many people miss you can absolutely overdo it
Over-diversification is a real problem! When you spread your investments too thin across too many funds, you dilute the impact of your winners. If one fund performs exceptionally well but represents only 2% of your portfolio, its amazing returns won’t move the needle much on your overall performance.
The Hidden Problem: Your Funds Might Be Twins
Here’s something many investors don’t realize: mutual funds often own the same stocks. This is particularly true with large cap funds.
Let me explain. Most large cap equity mutual funds invest in the biggest companies on the market. So if you buy 5 different large cap funds, you’re likely owning the same stocks 5 times over – just in different proportions. You’re not actually diversifying; you’re duplicating.
The Magic Number: How Many Funds Should You Actually Own?
So what’s the ideal number? After analyzing portfolios for years, I’ve found that around 8 mutual funds (+/- 2) hits the sweet spot for most investors. But this isn’t random – there’s method to this madness.
Let’s break down what your mutual fund portfolio might look like:
Large Cap Mutual Funds: 1-3 funds
Large cap funds invest in established companies with stable growth. Since these companies are limited in number, owning more than 2-3 large cap funds creates significant overlap. One well-chosen large cap fund might be enough for many investors.
Mid Cap Mutual Funds: 1-2 funds
Mid cap companies have higher growth potential but come with increased risk compared to large caps. While there are more mid cap companies than large caps, limiting yourself to 1-2 funds in this category makes sense for most investors.
Small Cap Mutual Funds: 1-2 funds
Small caps offer potentially meteoric growth but can also crash spectacularly. They’re the wild cards of your portfolio. Even though there’s less overlap in this category, the high volatility means you should probably limit your exposure to 1-2 small cap funds.
Debt Funds: 1-2 funds
Debt funds invest in bonds and provide stability to your portfolio. Since most debt funds provide similar returns, there’s little benefit to owning multiple funds in this category.
Sectoral/Thematic Mutual Funds: Very Selective
These funds focus on specific industries or themes. My rule of thumb: only invest in sectors you genuinely understand well. If you’re a tech professional who understands the nuances of the technology sector, a tech-focused fund might make sense.
Why This Works: Quality Over Quantity
The approach I’ve outlined focuses on intentional diversification rather than random collection. With about 8 funds strategically spread across different market segments, you achieve:
- Enough diversification to protect against single-fund or single-company failures
- Sufficient concentration to benefit when your investments perform well
- A manageable portfolio you can actually track and understand
- Less overlap between your holdings
Signs You May Have Too Many Mutual Funds
Not sure if you’ve gone overboard? Here are some warning signs:
- You can’t name all your funds without looking them up
- Your quarterly statements take forever to review
- You notice many of the same companies appearing across multiple fund reports
- Your portfolio performance consistently matches the broader market despite paying active management fees
- You’re spending too much time managing your investments
Real Talk: Adjusting Your Strategy Based on Your Situation
While 8 (+/- 2) funds works for many people, your situation might be different:
For Beginners
If you’re just starting out, even 8 funds might be too many. Consider beginning with 3-4 funds:
- A large cap fund
- A mid/small cap fund
- A debt fund
- And perhaps an index fund that tracks the broader market
For Seasoned Investors
If you’re experienced and have the time to actively monitor your investments, you might successfully manage 10-12 funds, especially if you’re including international exposure or specialty sectors.
For Retirement Planning
As you approach retirement, you may want to simplify your portfolio. Many retirees find that 5-7 well-chosen funds provide sufficient diversification while being easier to manage.
The Bottom Line: Less Can Be More
The goal isn’t to collect mutual funds like trading cards. The goal is to build a strategic portfolio that works for YOU.
In my experience, most successful investors focus on quality over quantity. They understand their investments thoroughly, keep overlap to a minimum, and maintain enough diversification to sleep well at night without diluting their returns.
So take a hard look at your portfolio. Are you holding too many funds that essentially do the same thing? Or are you concentrated in too few options? Finding that middle ground – around 8 well-chosen mutual funds – might be your sweet spot.
Practical Steps to Right-Size Your Mutual Fund Portfolio
If you’re currently holding more funds than the recommended range, don’t panic! Here’s how you can strategically consolidate:
- List all your current mutual funds by category (large cap, mid cap, small cap, debt, etc.)
- Check for overlap – Look at the top 10 holdings of each fund to identify duplications
- Compare performance – Within each category, keep the best performer(s) and consider eliminating the rest
- Consider tax implications – Plan your consolidation to minimize capital gains taxes
- Maintain proper asset allocation – Ensure your simplified portfolio still matches your risk tolerance
FAQ: Your Burning Questions Answered
Can I just buy one mutual fund that does everything?
Yes! Balanced funds and multi-asset funds exist for this reason. However, a one-fund approach may not optimize returns for different market segments.
Do index funds count in this total?
Absolutely. Index funds are a type of mutual fund and should be counted in your total.
Should international funds be part of my 8-fund portfolio?
They can be! International exposure is valuable for diversification. Just make sure it fits within your overall strategy.
What if I invest through a 401(k) and also have a separate brokerage account?
Count all your investments across all accounts when determining your total number of funds. This gives you a true picture of your diversification.
How often should I review my fund lineup?
At minimum, conduct an annual review. But also reassess whenever your financial situation or goals change significantly.
Final Thoughts
Remember, mutual funds themselves are already diversified instruments. Each equity fund typically holds 50-100 different stocks! So even with “just” 8 funds, you could indirectly own pieces of hundreds of companies.
The key isn’t maximizing the number of funds – it’s optimizing your portfolio to achieve your financial goals with manageable complexity. For most investors, that sweet spot falls around 8 funds, strategically distributed across different market segments.
So take a deep breath, review your portfolio, and see if you can simplify without sacrificing diversification. Your future self (and your sanity) will thank you!
How Many Mutual Funds Should I Own?
Mutual funds are of many types.
Large cap equity mutual funds invest only in large cap company shares. Investing in many large cap mutual funds is not necessary. One well-chosen large cap mutual fund should be enough.
Mid cap equity mutual funds invest in mid cap companies only. Mid cap companies grow at much higher rates when compared to large cap companies. At the same time, the risk is also much higher.
After careful research, you can consider owning a few mid cap mutual funds. The chances of overlap of ownership of shares is lower in the case of mid cap mutual funds because the number of mid cap companies is much higher.
Small cap mutual funds, as the name suggests, invest in small cap companies. Small cap companies are very volatile and can lead to meteoric rises and spectacular falls. The risk in case of small cap mutual funds is very high.
The chances of overlap of shares are lower in the case of small cap mutual funds. But it must be remembered, these mutual funds are very risky.
Debt mutual funds, invest money in bonds and other market instruments. They are low risk, low returns mutual funds. Debt mutual fund returns are very consistent over time and somewhat similar.
Sectoral mutual funds invest money in certain sectors or industries only. From a risk perspective, investing in a sector mutual fund is almost the same as buying shares in one industry only. You should have good knowledge of a certain sector to pick up a mutual fund in any given sector.
Over-Diversification of Mutual Funds
The aim of diversification is to spread risk. If you invest too much in one company’s stock, you are at great risk.
If something happens to that company, a significant portion of your money could get wiped away. So to mitigate that risk, you buy shares of many companies.
And to mitigate risk further, you buy shares of companies from different industries. So even if one entire industry is performing poorly, a good percentage of your money will still remain safe.
But if you invest in too many companies, and one of them does very well, your investment won’t gain much. The company that did well would have had a very small impact on your total investment. So you should limit yourself to owning a few shares from most industries.
But should you apply the same logic to your mutual funds? No, not really. This is because equity mutual funds themselves buy shares from very diverse industries.
Typically, equity mutual funds at any point are invested anywhere between 50 to 100 shares. So when you invest in an equity mutual fund, you are indirectly owning shares of that many companies. Your portfolio is already very diversified!