In taking a look at the investment allocations of some of my new clients, I've noticed a common theme..over allocation. Recently, we took over a retirement plan for a company, and as part of that we've been going over each employees account to see how they've been invested prior to us taking over management. Almost every single 401k that I've looked at owns more mutual funds than is necessary.
What? You're probably thinking how you've always heard "diversifying" (which is where an investor spreads his/her money around in an account to take some of the risk off by owning different industries/sectors/geographic regions) is the way to approach the markets and try to minimize downside risk..this is true, to a certain extent. Having ones money spread amongst different sectors such as technology and financials is a great thing, or between pharmaceuticals and consumer durables, but when it comes to owning and trying to diversify with mutual funds, look at the holdings and fees associated with the funds. Question: Would you want to own two mutual funds, both of which own the same stocks and have performed on average the same way? I would say no and here's why. If you own two funds that are similar and own the same things, then you really aren't diversifying your account at all by using two funds because the funds are the same! If you are going to take $10,000 and allocate $5,000 to one and $5,000 to the other fund in order to "diversify", then that's a great thing. BUT, if both of those funds own the same stocks, then you're not really diversified.
Another draw back are the management fees associated with owning mutual funds. It's always important to look at the overall fees that funds carry and by doing so you can actually improve your overall returns by avoiding fees such as loads, 12B-1 fees, and transaction costs (and if someone tells you that you have to pay these, then I wouldn't play poker with them).
Here's an example of over diversifying:
You have a 401k account that is invested in the following mutual funds:
American Funds Growth Fund Of America (large cap fund)
Van Kampen Value Opportunity (large cap fund)
Davis New York Venture (large cap fund)
- and then a couple of other mid cap and small cap funds
My point is this, why own THREE large cap funds that pretty much own the same stocks? Instead of over weighting your account with 3 large cap funds, why not own the BEST large cap fund, own the BEST mid cap fund, the BEST small cap fund, and the BEST foreign fund (not to mention a bond fund if that's what you desire). So that being said, if you have a 401k account, take a look at it to make sure that you aren't over diversified and that you dont own overlapping funds, because in the end it's all about investing your money in the best performing and managed mutual funds out there.
Ok now I'm off my soap box about mutual fund diversification. At some point, I'll write about what criteria I look for when I'm working with a client on selecting the appropriate fund for them and I'll even mention a few of the funds I've found to be the best to own.
(as always any of the investment funds I've mentioned above do not represent a suggestion to buy or sell)
