This week I want to talk about mutual fund portfolio construction. There are two ways to approach investing. Either you think you can beat the market, or you don’t. If you think you can beat the market, you try to pick likely areas to invest. If you don’t, you buy the whole market (i.e. through a stock index fund).
But many people do neither when they buy mutual funds. They buy a growth fund, a conservative fund, a big cap fund, and a small cap fund, international fund, etc., etc. Each fund may have 200 stocks. They might have 10 funds and 2000 stocks. When they are done, they own as many stocks as the person who is indexing. They own the whole market, but they are paying fees for active management. Plus it’s a lot more hassle having 10 mutual funds than it is 2 or 3.
That’s about the number that makes sense. 2, 3, at most 4 mutual funds. That’s all you need. If you’re trying to match the market, you buy 1 index fund. If you’re trying to beat the market, you buy 1 or 2 stock funds. In addition you might have a bond fund or an international fund for diversification. But that’s all.
Remember that a mutual fund is not a single investment, but a collection of many investments. When you’re buying funds, don’t over diversify. Buy a few and save time, hassle and money.