Aim to diversify
When going about investing it is important to keep diversified, whether you are Warren Buffet, or the kid next door with the educational IRA, although you could argue a kid that age really doesn’t need to diversify, but I’m not going to argue that point here.
One of the primary reasons investors buy into mutual funds is for the sake of diversification. Especially those of us do not have enough capital to buy ten or twelve single stocks. You buy into an equity fund and all of a sudden you own a myriad of companies. Congradulations, you’re diversified!
And now that we’re diversified, why not go out and buy a couple dozen mutual funds and really be diversified? Hold on there tiger, there is such a thing as over diversification, or diluting your returns. If a mutual fund manager has too many holdings he runs the risk of diluting his returns. He has so many equities that his portfolio can go nowhere. When the market is good, he has so many stocks that he ends up with enough losers to weigh down his winners and he gains nothing.
Your mutual fund manager has to know how many issues constitutes diversification and at what point does one begin to over diversify. Your fund manager also has to watch the over all size of his funds portfolio as well. A very large portfolio asset wise is hard to remain nimble and able to change with market conditions. So a fund has to be big enough to be diversified but not too big to move around as needed.
The bench mark for mutual funds to beat is the S&P 500 and it has proved to be an elusive bench mark for a majority of mutual funds. According to Morning star, over a one year period only 110 funds beat the S&P 500. It gets a little bit better over the five year period where 304 funds beat the index.
So why does an fund underperform the index. The very thing that enables the funds to outperform the index is the very thing that makes them underperform; and that is management. You put a group of guys at the helm of the fund and you hope they can balance re rebalance their way into the ranks of those funds who outperform the index. Unfortunatley, those same guys can also trade their way out of the list of winners as well.
Another factor that has been making the funds underperform is the fees involved. If you start by only buying no load funds then you’re off to a good start. However, all funds have operating expenses and those are enough at times to cause a fund to perform poorly. It’s a good idea to use expenses as a factor in your choice of funds.
Lastly, for the sake of diversification, if you have fifteen grand in the market you don’t need a dozen funds to be diversified. That’s more like diluting your returns. Instead why not buy an S&P500 index fund, and then pick three other funds and be done with it. That way you are diversified and not overly so.
Good luck and happy investinga
Comments
R.Johnson
October 31, 2009
Just owning mutual funds does make you diversified. To really diversity, you need to put money into equities, bonds, currencies, commodities, and probably more. Just look at the last bust. Both bonds and stocks took a beating. And almost no mutual fund portfolios escaped the carnage. Diversification across asset classes is really what's needed but the big brokers don't tell you that.
In terms of equity diversification, I see no reason not to buy an index fund. Very few, if any actively managed mutual funds have been able to beat an index fund over the long term plus you're paying extra for the active management.
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