I recently heard a story about a woman who owned 84 mutual funds. So what, you might say? Well, having too many mutual funds can lead to several problems:

• Time crunch – difficulty finding the time to stay up on developments that could negatively impact your portfolio performance such as a fund manager retirement.
• Increased risk - due to overweighting in a particular stock owned by several different mutual funds.
• Diluted returns – if you have too many mutual funds, you could see the returns canceled by the losses in a one-to-one ratio such that your portfolio performance goes nowhere.

Conventional investment wisdom tells us to diversify our holdings so that we minimize risk and maximize return. That is sound advice but exactly how many mutual funds should you own to achieve that diversification? The answer to this question varies depending upon your investment goals but you can use a standard rule of thumb to help make this decision.

Investors have 13 standard asset classes from which to choose when it comes creating a diversified portfolio. As a general rule of thumb, your portfolio should have no more than 11-13 mutual funds. You can further reduce the number of funds you own and still stay diversified by incorporating the following types of funds:

Balanced asset allocation funds – also known as hybrid funds, the balanced fund invests in a mix of domestic stocks, bonds and cash within one fund.

Blended fund – invests in domestic stocks of various sizes (large-, mid-, and small-cap) and mixed characteristics (value and growth) within one fund; typically you will find blended funds that focus on large/mid-caps and separate funds that focus on small-caps.

Index funds – using index funds would allow you to have as few as 4 mutual funds: one fund representing the entire US stock market (i.e., Wilshire 5000 Index), one fund covering the total international stock market (i.e, tracks the performance of the Total International Composite Index), one fund covering the total US bond market (i.e., tracks the performance of the Lehman Brothers Aggregate Bond Index) and one money market fund.

If you have more than 13 mutual funds, start paring back. Morningstar has some excellent tools to help you with this task. You can use their Porfolio Allocator to create a portfolio of funds that has the asset mix that you desire. Alternatively, you can rebalance the holdings in an existing portfolio. Note: You must register for a free membership in order to use this feature of Morningstar. Use the Instant X-Ray to understand your portfolio's basic characteristics at a glance, including its asset allocation, exposure to different investment styles, and other important factors.

Financially Savvy provides the information in this article for educational purposes only and it does not constitute investment advice either given or implied. Before making any investments or pursuing any money management technique, always consult your CPA for tax implications and your financial advisor to understand how such changes will impact your long-term plan.

About the Author:

Catie Fitzgerald is a 10+ years veteran of the money management profession and the founder of Financially Savvy. Financially Savvy provides investors with the education and resources necessary to gain confidence in making their own financial decisions. We offer a variety of educational venues including classroom sessions, one-on-one coaching, and online resources. If you have a personal finance question you would like answered, contact Catie at cfitz@financiallysavvy.com

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