Mutual funds: how many should you own?

Many investors caught (unreadable text) the latest "hot" funds touted in the press, amass mutual funds like philatelists collect stamps or beach-combers gather seashells. However, investment experts say owning too many mutual funds actually can be counter-productive.

How many mutual funds should you invest in? There is no magic number, and there is fierce debate among experts. Some say as few as four, others as many as 20. The happy median seems to be around 10 to 12. The best answer depends on each investor's goals and objectives, amount available for investing, and risk tolerance, the Institute of Certified Financial Planners, Denver, Colo., recommends.

People buy mutual funds in part because most funds own dozens of--sometimes more than 100-stocks. Most investors can't afford that many stocks on their own. So, if one fund can provide that kind of diversification, doesn't it make sense to buy many mutual funds to own even more stocks? No, according to recent studies. Two researchers published an article in the Journal of Investing stating that they found owning just for mutual funds reduced investor risk by 75%. Owning more than eight funds, on the other hand, did little to reduce risk.

It isn't just a matter of the number of funds you own, either, but what types. Suppose you have eight funds in your portfolio, but six of them are growth funds, which seek price increases in stocks, not income through dividends. Although each fund will invest in different stocks, they likely will own many of the same ones since, at any given time, there is a limited poll of quality stocks. Studies have found similar types of mutual funds overlapping each other by as much as 25% or more. Thus, you are not as diversified as it may appear. Furthermore, if growth funds in general do poorly, most likely all six of yours will, too--and so will your portfolio...