How Many Mutual Funds Do You Need to Build a Diversified Portfolio? (2024)

Investment advisors are oftenasked how many mutual funds they should have in a 401(k) or another long-term portfolio to maintain diversification and thereby limit their risk and potential investment losses.

Experts claim that a diversified portfolio consists of eight to 60 stocks. Given that the average mutual fund is a basket of 36–1,000 stocks, you can technically achieve a diversified portfolio with only one fund. But investors who prefer greater diversification set the limit at eight.

The right number of mutual funds for you depends on several factors, including your investment objective and tolerance for risk. If you're wondering how many funds to include in your portfolio, there are a few strategic principles of diversification you should follow.

Note

One study of sample portfolios found that a portfolio with around 48 underlying stocks eliminated 98% of market risk.

Basics of Diversification With Mutual Funds

Diversification with mutual funds refers to the spread of money across different investments.

The sage expression "don't put all your eggs in the same basket" describes the essence of diversification because it illustrates the need to spread your risk across several areas.

Put differently, if you put all of your money into one investment, you're probably not diversified. But here's where investors often make their biggest mistake with diversification: They think that diversification can be achieved if they simply spread their money across several different mutual funds. But if you put your eggs into different baskets that share virtually the same characteristics, that's not diversification.

When deciding on how many mutual funds and which funds you should have in your portfolio, aim for diversification in your portfolio at two levels: across asset classes (like stocks, bonds, and cash) and within asset categories (industries and companies).

Note

The underlying securities in the mutual funds you hold can be as big a determinant of how diversified your portfolio is as the number of funds you hold.

Diversification Across Asset Classes

A portfolio that is exclusively invested or too heavily weighted in stocks might sound good in theory because stocks can rise dramatically in price during an economic boom, and you might reap the rewards in the form of higher returns. But it's risky because it subjects your portfolio to outsized losses in the stock portion of your portfolio—and significant declines in the overall value of your portfolio—when the market declines. On the flip side, investing too much in cash or otherwise incorporating too little risk in your portfolio may mean that it doesn't generate sufficient returns to meet your goals.

To balance risk and reward, spread your money across the different asset classes you choose (stocks, bonds, and cash, for example). The specific spread you choose should factor in these key criteria:

  • Investment goal: You might be investing for capital appreciation (growth of the investment over time) or income, for example. If capital appreciation is your goal, you might want to weight your portfolio more heavily toward stock than someone who wants to draw a steady income.
  • Risk tolerance: Risk refers to the potential to lose the money you invest. Assets that carry greater returns also tend to come with greater risk. If you have a high risk tolerance, you might put more of your money in stock; if you're extremely risk-averse, you might want to put more of your money in money market funds.
  • Time horizon: This is the period over which you plan to invest. Generally, investors with a long time horizon can take more risks and invest more heavily in stocks than those who only intend to invest over a short period (someone nearing retirement, for example).

Asset Category Diversification

Although you may have several different funds in your portfolio, if some or all of them have the same or similar holdings, your portfolio has a major flaw known as fund overlap.

For example, let's say that you divide your money equally between four different mutual funds; each represents 25% of your portfolio. Each fund has a different name and therefore appears to have different objectives. Suppose that one is a growth fund, another is a growth-and-income fund, a third is an S&P 500 index fund, and a fourth is an international fund. It is possible that the first three funds are nearly identical and that the fourth has many of the same company holdings as the first three, in which case they are too similar to provide the diversification you need to spread risk, or to successfully "put your eggs into different baskets."

To avoid making this mistake, pick mutual funds with holdings in different asset categories. For example, a simple four-fund allocation that is diversified could include one large-cap stock fund, one small-cap stock fund, one international stock fund, and one bond fund.

Each of these will likely hold completely different securities. But it's still important to review the underlying holdings of any funds you add to your portfolio to ensure that they don't have overlap.

How Many Mutual Funds You Should Hold

There's no magic number of funds to keep in a 401(k) or another portfolio for long-term investing. The right number of investments is one that ensures diversification but also factors in your investment approach.

If you prefer low-effort investing, consider buying a single fund. If you are prepared for more administrative work when it's time to rebalance your portfolio, choosing up to eight offers an opportunity to increase the number of asset categories you include in your portfolio. No matter how many funds you settle on, you can likely put together a portfolio that accommodates your choice:

  • One fund: All-in-one funds like target-date funds for investors retiring in a certain year make it possible to invest in just one fund and be diversified.
  • Two funds: Increasingly popular two-fund portfolios with a stock fund and a bond fund may allow for increased diversification.
  • Four funds: A four-fund allocation could include a domestic stock fund, a domestic bond fund, an international stock fund, and an international bond fund.
  • Eight funds: Opt for large, mid-size, and small domestic stock funds, international and emerging market stock funds, two bond funds, and a money market fund to build a more complex eight-fund portfolio.

Frequently Asked Questions (FAQs)

What are the main types of mutual funds?

There are four categories of mutual funds: equity, money market, fixed income, and hybrid. Equity funds are also referred to as stock funds. These funds are usually focused on publicly traded companies, and their values can rise and fall quickly over a short period. Money market funds are among the safest funds options as they focus on short-term, high-quality investments made by the government, U.S. corporations, and state/local governments. Fixed income funds are also called bond funds. They provide a profit through dividend payments focused on government and corporate debt. Last but not least are hybrid funds that combine different funds to account for the specific investor's needs.

What are the best mutual funds?

The best mutual funds can ride out a weak economy and bring in higher returns in the long game. When we pick the best mutual funds, we look for a few characteristics to know they are good long-term investing prospects. These include a low starting point, diversified funds with a strong balance among their assets, and those from different sectors. If you are looking for the best mutual funds for retirement, we would also suggest those that provide a higher comfort level and relatively low risk.

How Many Mutual Funds Do You Need to Build a Diversified Portfolio? (2024)

FAQs

How many funds should be in a diversified portfolio? ›

You should therefore only keep as many funds in your portfolio as you're comfortable monitoring. For example, if you hold 10 or 20 different funds, you'll need to keep a close eye on the changing value of all these investments to make sure your asset allocation still matches your investment goals.

How many mutual funds should be in my portfolio? ›

While there is no precise answer for the number of funds one should hold in a portfolio, 8 funds (+/-2) across asset classes may be considered optimal depending on the financial objectives and goals of the investor. Further, higher allocation of portfolio to the right fund is of crucial importance.

What is the 75 5 10 rule for diversified mutual funds? ›

Diversified management investment companies have assets that fall within the 75-5-10 rule. A 75-5-10 diversified management investment company will have 75% of its assets in other issuers and cash, no more than 5% of assets in any one company, and no more than 10% ownership of any company's outstanding voting stock.

What is the 25% diversification rule for mutual funds? ›

Let's start with the 25:1 and 50:5 rule, a sort of “bright line test” with two simple guidelines: One issuer cannot contribute more than 25% of the portfolio's fair market value. Five or fewer issuers cannot contribute more than 50% of its fair market value.

Is it better to invest in one mutual fund or multiple? ›

The decision to invest in one fund or multiple funds depends on your investment goals, risk tolerance, and diversification strategy. Investing in one fund can be simpler and more straightforward, while multiple funds can offer broader diversification across different assets and sectors.

How much money do I need to invest to make $1000 a month? ›

Reinvest Your Payments

The truth is that most investors won't have the money to generate $1,000 per month in dividends; not at first, anyway. Even if you find a market-beating series of investments that average 3% annual yield, you would still need $400,000 in up-front capital to hit your targets. And that's okay.

Is 5 mutual funds too many? ›

Maybe 3 at best. Beyond that, it doesn't make sense as there will be a great overlap in the shares owned by your mutual funds. Mid Cap Mutual Funds: Up to 2. While you might get higher returns, the risk you expose yourself to is also higher.

Are 10 mutual funds too many? ›

There is no one right answer to questions like how many funds should I invest in. But just adding new funds to the portfolio to 'diversify' or reduce risks doesn't work. So, in general, having 1-2 schemes in the chosen fund category would be sufficient.

What is the 4% rule for mutual funds? ›

The 4% rule says people should withdraw 4% of their retirement funds in the first year after retiring and take that dollar amount, adjusted for inflation, every year after. The rule seeks to establish a steady and safe income stream that will meet a retiree's current and future financial needs.

What if I invest $50,000 in mutual fund? ›

By investing Rs 50,000 per month one time, he could look to accumulate Rs. 19.16 lakhs in twenty years with 20% annualized returns. We have taken a weighted average of the return of each fund after considering the lower 3-year and 5-year returns as the return over the 20 years.

What if I invest $10,000 in mutual fund? ›

If you start investing Rs 10,000 in an equity mutual fund, you can accumulate Rs 1 crore in 20 years. This is assuming a 12% annual return on your investment.

What is the 90 day rule for mutual funds? ›

the reinvestment must be made within a specified period of time (e.g., 90 days, although time periods may vary substantially across fund families); the redemption and reinvestment must take place in the same account; the redeemed shares must have been subject to a front-end or deferred sales charge; and.

What if I invest $1,000 a month in mutual funds for 20 years? ›

If you were to stay invested for a shorter duration, say 20 years, you'd invest Rs 2,40,000, but your portfolio value would be Rs 9.89 lakh. A decade-long investment of Rs 1,000 per month would equal Rs. 2,30,038, as compared to Rs. 1,20,000 invested over the same period.

How should I divide my mutual funds? ›

Accordingly, your portfolio must be divided between liquid funds and debt funds. Within debt funds how much should be in duration above 5 years and duration below 5 years and how much should be in duration under 1 year. That will depend on your outlook on interest rates.

What is the 30 day rule for mutual funds? ›

Under the 30-day rule, if you sell or redeem shares of a mutual fund within 30 days of purchasing them, you may be subject to additional fees or penalties. The purpose of this rule is to discourage short-term trading and promote long-term investing.

What is considered a good diversified portfolio? ›

Having a mixture of equities (stocks), fixed income investments (bonds), cash and cash equivalents, and real assets including property can help you maintain a well-balanced portfolio. Generally, it's wise to include at least two different asset classes if you want a diversified portfolio.

What is considered a well diversified portfolio? ›

Diversification means owning a variety of assets that perform differently over time, but not too much of any one investment or type. In terms of stock investing, a diversified portfolio would contain 20-30 (or more) different stocks across many industries.

How many funds do I need in my portfolio? ›

Financial planners say it is difficult to put a cap on the number of schemes in an investor's portfolio, as investors increasingly use mutual funds to meet both long-term and short-term goals. However, they feel investors should restrict themselves to 10 schemes, as a higher number is difficult to monitor and manage.

What is a typical 3 fund portfolio? ›

A three-fund portfolio is a portfolio which uses only basic asset classes — usually a domestic stock "total market" index fund, an international stock "total market" index fund and a bond "total market" index fund.

Top Articles
Latest Posts
Recommended Articles
Article information

Author: Nicola Considine CPA

Last Updated:

Views: 6145

Rating: 4.9 / 5 (49 voted)

Reviews: 88% of readers found this page helpful

Author information

Name: Nicola Considine CPA

Birthday: 1993-02-26

Address: 3809 Clinton Inlet, East Aleisha, UT 46318-2392

Phone: +2681424145499

Job: Government Technician

Hobby: Calligraphy, Lego building, Worldbuilding, Shooting, Bird watching, Shopping, Cooking

Introduction: My name is Nicola Considine CPA, I am a determined, witty, powerful, brainy, open, smiling, proud person who loves writing and wants to share my knowledge and understanding with you.