How Many Mutual Funds Do You Need?

It seems that investors believe that there is an optimum number of mutual funds to own. But, like prunes there is no magic number. The right combination depends on the individual. Still there are some rules of thumb that help make sense in selecting from among the over 10,000 funds for sale.

Three Considerations In Deciding How Many Funds You Should Own

1. How Much Money Do You Have To Invest?
Mutual funds have minimum buys. You simply can't get into a fund for less than its minimum. Some minimums are quite high, like the Vanguard 500 at $3,000. Others like TIAACREF 1-800-223-1200 can be as low as $250. Still others, like Babson Growth, 800-422-2766, Homestead Value 800-258-3030, and Nicholas Fund 800-227-5987 have $500 minimums. Strong 800-368-1030, USAA 800-531-8722, and T.Rowe Price 800-255-5132 accept a low minimum, if you authorize an automatic $50 per month withdrawal from your checking account.

If you have more money to invest, there are good reasons to choose a number of funds, even if you have found a great performer. Managers can leave and your fund can face a bumpy ride until a new guru shows up. Fidelity Magellan floundered under several managers after superstar Peter Lynch left the fund.

You also want a number of funds for diversification. But, multiple funds alone do not mean true diversification. There are more funds than there are listed stocks. Don't delude yourself into believing that there is safety in numbers alone. Your mutual funds may overlap in holdings. Read the prospectus before you buy. It's the only way to know.

2. Have You Filled All Classes Of Assets?
Asset allocation, one of the Market Maven's major tenets, dictates that you cover all classes of assets. Since most mutual funds invest in one class only, you'll need at least as many funds as classes of assets you want in your portfolio. Here's a real life example for a $100,000 portfolio:
1-large cap domestic stock fund; 3-domestic and foreign large caps; 1-contrarian fund; 2-value funds; 2-midcap funds; 1-money market; 1-midcap foreign.

3. How Paperwork Phobic Are You?
Financial marketers, like Charles Schwab and others, know that reading multiple statements can be a drag. That's why they offer a single statement and even allow you to purchase certain no load funds for no fee or a small transaction costs. So, if you stick with the same company, it's not necessary to limit the number of funds you own just to cut your paper work. Pay the small service charge necessary to have all the funds held in one account and get a consolidated statement.

Two Rules For Adding And Subtracting Funds

1. Dollar Cost Average In
After you've determined your allocation and selected one or more funds that are appropriate for each, it's time to buy. Gather your money together and make the minimum buy for each fund. That will give you a chance to increase the shares through a method called "dollar cost averaging," investing the same amount each month in the same fund. In this way, you pay the average price of the fund over time, getting the benefit of dips in price. Statistics show that you come out ahead in the long run.

2. Dollar Cost Average Out
When you spot a dog, or find that you have too many funds in one class, it's time to sell. But you need not bail out all at once. Simply dollar cost average out of a fund. Sell the same dollar amount each month over a period of six months or so. You get back the average price of the fund. Use common sense: If a fund is about to tank on bad news, just dump it and get out.

Other indexes

  • All In One -- The Wilshire 5000 Index. You may not have heard the name, but you can't miss the index. The Wilshire 5000 (despite its name) consists of all of the over 7,000 US stocks readily available on the American equity markets.
  • International Indexes -- Nearly every foreign exchange has an index for itself. Try the one for London, the FTSE. Or, look for a truly international index, like the Schwab International Index of 350 companies in already industrialized and developed countries.
  • Real Estate -- Morgan Stanley has the Morgan Stanley REIT Index of real estate investment trusts.
  • Small Cap -- The Russell 2000 Index tracks a huge number of these small capitalized firms.
  • Tech Stocks -- Here is a toughie. There are almost as many tech stock indexes as there are tech stocks. Each one is competing to be a true measure of the volatile tech stock sector. Unfortunately, many of the indexes being proposed are not true indexes, but are mere vehicles for selling a high tech mutual fund. With this in mind, remember: Bigger is better. The more stocks in an index, the more representative it is going to be. Try the Goldman Sachs Technology Index -- it has 190 stocks. (As compared to the Morgan Stanley High Tech 35 or the Merrill Lynch 100).

Also see: Investors Exchange board.

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