You’ve probably heard for years that diversification is one of the keys to successful money management. And as many employees of scandalized companies have recently learned, lack of diversification can mean the difference between a comfortable retirement and possibly none at all. (Note, however, that diversification does not ensure a profit or protect against loss in a declining market). But are you one of those investors who collect mutual funds like other people take aspirin? If two are good, then four must be better?

It’s easy to get into the rut of owning an overabundance of funds. You might have a few that you’ve owned for decades, several more that you recently bought because they were hot performers, and some in your IRA that got rolled over from your 401(k) plan. But what has this accomplished? Could you possibly have diversified yourself to the point of diminishing returns and now have done more harm than good?

What’s the Right Number?

So how many funds are too many? There’s no magic number, and each investor’s situation is different. But think about how much time you spend monitoring your portfolio. Does the paperwork pile up when the tax forms start coming in after the New Year? Mutual funds were meant to make life simpler.

Suppose your financial plan calls for a specific balance of asset classes, and each year you make adjustments among your investments in order to maintain that balance. This means that you would sell part of the asset classes that have done well and buy more of the asset classes that have fallen behind. The more funds you own, the more complicated this becomes, and the greater the possibility of sizable capital gains taxes.

Over-diversification might possibly increase portfolio risk. What if two of your funds are large-cap, growth-oriented and both have large holdings in the same stock? If that stock were to take a dive, both of your investments would suffer.

After many years of investing, you may not be sure whether or not you own too many funds. This might be a good time to go over them and think about why you bought each one. Would you still buy them today? Have any of the funds changed their investment style over the years, and how might that impact your overall financial plan? Is there now overlap of investments within the funds that exposes you to greater risk?

Look at your funds’ websites or semi-annual reports. Do the same company names appear in the top ten holdings of several of your funds?

If you think that your basket of mutual funds has become too overwhelming to manage or there might be investment overlap resulting in less diversification and greater risk, consider the capital gains tax possibilities before you start consolidating.

For a free analysis of your mutual funds and which you should consolidate, including overlap that might be within your portfolio, call or e-mail my office.