Diversifying too much among funds can dilute advantages of owning them

MUTUAL FUNDS

September 25, 1994|By New York Times News Service

Here's a good exercise for mutual fund investors: List all the funds in which you have investments on an index card. If the names don't easily fit on one side, you probably are a mutual fund junkie.

Owning too many mutual funds is the kind of problem that creeps up on longtime fund investors. Each time you have cash to invest, you buy the best-performing fund of that period.

Gerald W. Perritt, editor of the Mutual Fund Letter in Chicago, frequently reviews investors' fund portfolios and says: "You can almost go down the list and say, 'Aha, three years ago these two funds were hot, so he bought them. Then this one was highly touted in the newspaper, so he bought that one. Later this one topped a magazine's rankings, so he bought that one.' "

The problem arises when you fail to weed out poor-performing funds at the same time. According to the Investment Company Institute, 18 percent of fund investors have holdings in six or more funds.

In Mr. Perritt's experience, people frequently hold two or three dozen funds. "I was shocked when one fellow had 106 mutual funds," he said.

"I have yet to come up with a good solid reason why a person should own more than a dozen funds," Mr. Perritt said.

In fact, there are plenty of reasons to own far fewer.

Holding too many funds -- in essence, overdiversifying -- can dilute performance rather than improve it, effectively creating an expensive index fund.

After all, even if a handful of your two dozen or so funds beat the market, it's likely that another handful will underperform.

If investors simply want performance that reflects the market, they can invest in an equity index fund and save themselves the higher management fees of actively managed funds.

Another problem with large fund portfolios is duplication. Edward Higgins of the Higgins Advisory Group in Darien, Conn., said: "Often, you take a look at the portfolio and all the funds are the same. Investors are not balancing styles of managers."

Such duplication can cost money. That's because similar funds often hold the same stocks.

Mr. Perritt studied the portfolios of some popular equity funds and found that 25 percent to 40 percent of the funds' assets were in the same stocks. So if one fund you owned sold Coca-Cola one day and another bought it, Mr. Perritt said, "you end up in the same place -- except you paid commissions to sell and buy back again."

Another problem: If you are buying load funds and you divvy up the investment into many small pieces at a variety of fund companies, you lose the economies of scale. Diversifying within a single fund family often can reduce loads and will certainly make the administrative paperwork easier.

And, of course, owning fewer funds means fewer decisions, a big plus to Burton Berry of the DAL Investment Co., a money manager in San Francisco.

In a typical account, Mr. Berry said, "we rarely have fewer than three common stock funds or more than six." Mr. Higgins and Mr. Perritt agree that a half-dozen funds should be sufficient for most investors.

Mr. Berry advises concentrating on funds managed in whatever style -- value or growth -- is currently hot. But in times of transition like these, when value managers have had a good run but growth managers are starting to take the lead, it is wise to diversify.

Current favorites at DAL Investment for long-term growth investors include the value funds Longleaf Partners and Oakmark, along with a growth fund, Montgomery Growth. More aggressive growth investors might add the Janus Mercury and Montgomery Emerging Markets funds.

Mr. Perritt suggests that a long-term growth investor might hold a small-cap growth fund like Vanguard Small Cap Stock; a small-cap value fund like Heartland Value; a medium- to large-cap growth fund like Crabbe Huson Equity; a large-cap value fund like the Yacktman Fund, and an international fund like T. Rowe Price International Stock.

Mr. Higgins recommends sticking with one or two fund families to save on loads, to ease the administrative burden and to make switching funds simpler. He likes the American Funds family, with its system of dividing each fund's assets among several managers.

"It has the habit of evening out the bumps in performance," he said. For aggressive growth investors, he suggests the group's Smallcap World and New Perspective funds, while for growth-and-income investors he likes the Capital World Growth and Income Fund and the Fundamental Investors fund.

Mr. Higgins also singles out the Fidelity Advisor funds, which are distinct from other Fidelity funds, for the maturity and track records of the portfolio managers.

Investing in a good growth and income fund, like FPA Paramount, is an easy and conservative way to widen an investor's market breadth. Asset-allocation funds, which move money between stocks, bonds and cash provide another way to broaden market exposure without stockpiling mutual funds.

Yet investors should be aware that asset allocation funds' nearly constant exposure to all markets can dull performance.

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