Diversifying Your Investment: Multiple Fund Families, Pros And Cons

Investing in multiple fund families is a topic that has been widely discussed in the financial world. Diversification is a common strategy to spread risk and ensure that investments are safeguarded from sudden risks. While it is generally recommended to diversify one's investments, it is also important to note that over-diversification can be counterproductive and prevent investors from making significant gains. In the case of mutual funds, it is important to understand the different types of funds available, such as large-cap, mid-cap, small-cap, debt funds, and sectoral funds, and their associated risks and potential returns. Additionally, the advantages of investing with a fund family, such as lower costs, sales charges, and access to research, should also be considered. Ultimately, the decision to invest in multiple fund families depends on the investor's financial goals, risk tolerance, and level of expertise.

Pros of multiple funds: diversification, lower individual risk, capturing different opportunities, flexibility and customisation, and cost-effectiveness

Keeping investments in multiple fund families has several advantages, including diversification, lower individual risk, capturing different opportunities, flexibility and customisation, and cost-effectiveness.

Diversification

Diversification is a fundamental investment strategy that aims to reduce risk and enhance long-term growth. By investing in multiple fund families, you can spread your investments across various assets, sectors, company sizes, and geographic regions. This diversification lowers your overall investment risk and protects against extreme declines in the market.

Lower Individual Risk

Multiple fund families allow you to invest in a variety of asset classes, such as cash, equity, bonds, real estate, and commodities. By allocating your investments across these different classes, you reduce the volatility and potential losses in your portfolio. This lowers the risk of losing a significant portion of your investment during market downturns or geopolitical events.

Capturing Different Opportunities

Different fund families offer access to distinct investment opportunities and strategies. By investing in multiple fund families, you can capture a wider range of opportunities and potentially benefit from various market trends. This allows you to take advantage of growth in different sectors or asset classes.

Flexibility and Customisation

Multiple fund families provide greater flexibility and customisation options for your investment portfolio. You can tailor your investments to align with your specific financial goals, risk tolerance, and time horizon. This customisation allows you to create a portfolio that suits your individual needs and preferences.

Cost-Effectiveness

Investing in multiple fund families can also lead to cost savings. Certain fund families offer discounts or other benefits to investors who demonstrate "brand loyalty" by investing in multiple funds offered by the same investment company. Additionally, some fund families provide access to investment research, news, and advisory services, which can help you make more informed investment decisions.

Risks of multiple funds: asset allocation, overlap and correlation

When considering whether to invest in multiple fund families, it is important to be aware of the risks associated with doing so. Three key risks to keep in mind are asset allocation, overlap, and correlation.

Firstly, asset allocation is crucial when investing in multiple funds. It is important to allocate your investments across different asset classes, such as equities, bonds, and real estate, and then choose specific funds within each class to maintain a balanced approach. Over-allocating to one sector or another can lead to inadequate diversification and increased exposure to specific sectors or securities.

Secondly, fund overlap is a common issue when investing in multiple funds. This occurs when an investor owns shares in several mutual funds or exchange-traded funds (ETFs) with overlapping positions. For example, if an investor owns both an S&P 500 index mutual fund and a technology sector ETF, there will be significant overlap with the FAANG stocks (Facebook, Apple, Amazon, Netflix, and Google). Fund overlap can reduce the benefits of diversification and create unseen risks, as it may lead to too much concentration in just a few companies' shares.

Finally, correlation between different funds can also impact the overall risk of your portfolio. When multiple funds have similar holdings or buy index funds, it can reduce diversification. For example, if two separate mutual funds both overweight the same stock or sector, the investor may be exposed to higher levels of risk than intended.

To manage these risks, investors should periodically assess their portfolio for overlap and correlation by analyzing the holdings of their funds and identifying common stocks or sectors. This can help ensure that the desired level of diversification is achieved and that the portfolio is aligned with the investor's goals and risk tolerance.

In summary, while investing in multiple fund families can offer benefits such as exposure to different markets and economies, it is important to be mindful of the risks associated with asset allocation, overlap, and correlation. By actively managing these risks, investors can make more informed decisions and build a well-diversified portfolio.

Mutual fund companies going under

While it is unlikely for a mutual fund company to go under, there are a few risks associated with investing in mutual funds that you should be aware of. These include:

• Market risk: This arises from the potential decline in the value of the securities within the fund. If the market experiences a downturn, the value of your mutual fund investments may also decrease.
• Interest rate risk: This primarily affects funds that hold bonds and other fixed-income securities. Rising interest rates can lead to a decrease in bond prices, impacting the value of your investment.
• Management risk: The performance of your investment is linked to the competence of the fund's management team. Poor investment decisions by the fund managers will negatively impact your returns.
• Tax implications: Withdrawing money from a mutual fund may have tax implications, especially if the investment has appreciated in value. You may need to pay taxes on any capital gains or distributions received.
• Fees and expenses: Mutual funds typically charge various fees, such as expense ratios, sales loads, redemption fees, and exchange fees. These fees can eat into your overall returns, so it's important to carefully consider the cost structure before investing.

To mitigate the risks associated with mutual fund companies going under, it is generally recommended to diversify your investments across multiple fund families. By investing in different fund families, you reduce the impact of negative performance in any single fund and lower the overall volatility of your portfolio. Additionally, investing in multiple fund families can provide you with access to a broader range of investment opportunities and allow you to take advantage of discounts or other benefits offered by fund families for showing "brand loyalty".

Diversification among fund types

Diversification is a key investment strategy to mitigate risk. By spreading your holdings across various industries, regions, or asset classes, you reduce the impact of negative performance in any single fund, keeping the overall volatility of your portfolio in check. This strategy is not just limited to asset classes and investment types but can also be applied to holding your investment assets at more than one mutual fund company or brokerage firm.

To achieve proper diversification, investors should focus on diversifying among several mutual fund types, rather than mutual fund companies. This mutual fund mix should include a blend of riskier equity funds, conservative fixed-income funds, and short-term-focused money market funds. The ideal mix depends on your current financial goals and the level of risk you are comfortable with.

For example, a well-diversified portfolio might include a mix of large-cap, mid-cap, and small-cap equity funds, as well as debt funds and sectoral funds. Large-cap equity funds invest only in large-cap company shares, while mid-cap and small-cap funds focus on companies with higher growth rates and higher risk. Debt funds, on the other hand, invest in bonds and other low-risk, low-return market instruments. Sectoral funds target specific sectors or industries.

It is important to note that over-diversification can prevent you from making good gains. Therefore, it is recommended to limit yourself to owning a few shares from most industries and choose a select number of funds from each category based on your knowledge and risk tolerance.

The number of funds to own depends on your financial goals and risk tolerance

The number of funds you should own depends on your financial goals and risk tolerance. Diversification is a common strategy to mitigate risk. By spreading your investments across different asset classes, industries, and regions, you reduce the impact of negative performance in any single investment. However, overdiversification can prevent you from making good gains.

When deciding how many funds to own, it's important to consider your financial goals and risk tolerance. If you are a young investor with a high-risk tolerance, you may want to invest more heavily in riskier equity funds. On the other hand, if you are older and more risk-averse, you may want to allocate more of your investments to conservative fixed-income funds and short-term money market funds.

Additionally, the number of funds you own can depend on the types of funds you choose. For example, large-cap equity mutual funds invest only in large-cap company shares, so one well-chosen fund should be enough. Mid-cap and small-cap mutual funds tend to have higher returns but also carry more risk. As a result, it's generally recommended to limit yourself to owning a few of these funds. Debt mutual funds, which invest in bonds and other low-risk instruments, typically offer consistent but low returns, so one or two of these funds is usually sufficient.

Ultimately, the ideal number of funds to own depends on your specific circumstances and financial goals. A good rule of thumb is to own around eight mutual funds, but this can vary depending on your level of expertise and comfort with risk.

Frequently asked questions