"When I began investing in mutual funds," a woman writes, "my main concern was safety. Not only did I spread my money among several different fund groups, I duplicated the same type of investment -- i.e., GNMAs with Benham and Vanguard, municipals with both Benham and Nuveen.
"Do I need this diversification for safety or should I keep all of my tax-free money with one company? Should I even put all of my funds with one family of funds?"
It isn't clear whether, in referring to safety, she worries about (1) .. the possibility of loss resulting from a fund's bankruptcy or the theft of a fund's assets or (2) the safety of principal that poor portfolio management can imperil.
Happily, safety as perceived in the context of business failure or theft should not be a concern when you invest in mutual funds.
As Richard C. Breeden, chairman of the Securities and Exchange Commission, commented recently, "Without government subsidies or taxpayer credit, investment companies have operated with remarkable safety."
For this, credit is due the drafters of the Investment Company Act of 1940 and its 1970 amendments, the SEC and state government agencies that have regulated the industry, and industry executives who have worked to win and hold public confidence, which had been shaken by insiders' self-dealing and reckless practices before 1940.
Worries about fund bankruptcy, based on seeing other financial institutions fail, don't take into consideration the differences between a fund and its sponsor -- usually its investment adviser.
Given the limits on borrowing, short selling and risky practices, it is virtually impossible to imagine that a fund's liabilities could exceed its assets, leaving it bankrupt.
Proper oversight by independent directors and SEC inspectors should suffice to eliminate the possibility that, say, high net redemptions, high expenses and poor management could melt a fund's assets.
Some investment advisers, on the other hand, have gone bankrupt, and others may do so in the future. Their creditors, however, can't touch fund assets -- the cash, stocks and bonds in which you have an interest -- because funds are separate corporations (or trusts).
The threat of losses resulting from theft or other wrongdoing is dealt with primarily in the 1940 act. Its safeguards include requirements of audits by independent public accountants, safekeeping of a fund's cash and securities by a qualified custodian (usually a bank, whose creditors can't touch them if the bank has problems), and a fidelity bond against larceny and embezzlement by officers or employees.
Riders on these policies also protect funds and their shareholders against losses from such modern hazards as fraudulent uses of computers and automated telephone systems, as well as unauthorized telephone instructions for redemptions or exchanges.
Funds also take out other insurance, including directors and officers' errors and omissions liability policies, to guard against losses resulting from negligence or breach of fiduciary duty.
With all these measures, you probably can conclude that the just-mentioned safety concerns alone don't indicate the need for diversification among fund families.
The threat to your portfolio's principal that is posed by poor fund performance is, however, something you do have to watch out for. It necessitates not only checking before you invest whether a fund's investment objectives and risk level are compatible with your goals and risk tolerance, but also monitoring funds after you invest to see whether they are living up to expectations.
It is consideration of objectives, risk and performance that probably will lead you to invest in two or more fund families.
Of the many that offer the nation's 3,500 money market, bond and equity mutual funds, not one has the leading performer in every category.
Since each fund means more performance data to watch, more records to keep and more lines to fill out on your tax return, you'll want to be sure that each fund contributes something to your portfolio. You don't need duplication.