Diversification is often said to be ‘the only free lunch’ when it comes to investing, and funds are perhaps the simplest way to achieve this.
Any investment fund represents a bundle of stocks, adding instant diversification to your portfolio. So, does it follow that more funds means more diversification and better returns, or is there a limit to how many funds it is sensible to hold?
“The key is to build a diversified portfolio because this helps you weather different market conditions,” said Clare Francis, savings and investments director, Barclays Private Bank and Wealth Management. “Diversification means spreading your money so it’s invested globally, giving you exposure to different countries and sectors, with a mix of shares and bonds.”
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This can be achieved, Francis added, by using a single fund, which some platforms offer as ‘ready-made’ options.
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“They invest in a mixture of bonds, shares and cash and they invest globally,” she explained. “The way they differ is the level of risk each fund takes, so all you need to do is pick a fund that best suits the level of risk you feel comfortable with.”
But it sometimes makes sense to hold more than one fund or investment trust in your portfolio. What are the benefits, and what is the ideal number of funds to hold?
Why might you want to hold more funds?
If you are a beginner investor, it can make sense to start out small and diversify your fund holdings from there.
“We see many investors start with a ready-made fund and add additional funds, or even buy shares in individual companies, once they get more confident,” said Francis. “If you don’t want to go down the ready-made route you can create a diversified portfolio yourself by buying individual funds that each invest in a different part of the market such as the UK, US, Europe, Asia and emerging markets.”
Some funds are more suitable for beginners just starting to build their portfolio. If you feel less confident, keep it simple to begin with – there is very little to be gained from adding a fund that you don’t understand to your portfolio when there are ready-made options out there that can take a lot of the decision-making off your plate.
Once you are more confident, you might want to add more funds to your portfolio in order to gain exposure to specific investment themes or sectors.
“If you prefer to build your own diversified portfolio, around 10 well selected funds can be more than sufficient to provide diversification across different asset classes, regions, market capitalisation and styles,” said Dzmitry Lipski, head of funds research at investing platform Interactive Investor.
The disadvantages of holding more funds
Adding more funds to your portfolio doesn’t necessarily mean you’re increasing your level of diversification.
“Holding too many funds can create unnecessary complexity and may result in investors owning overlapping investments without realising it,” said Barclays’ Francis.
Realistically, the more funds you hold, the less each is going to contribute to your overall returns.
“If you hold more than 20 funds, it is probably worth reviewing whether each one has a clear role and is genuinely adding something different to the portfolio,” said ii’s Lipski. “Too many funds can make a portfolio unnecessarily complicated and harder to monitor and rebalance.”
The more funds you hold, the higher the likelihood that several of them are duplicating exposure to the same stocks or assets – so holding more funds, beyond a certain level, doesn’t necessarily mean greater diversification.
“Rather than focusing purely on the number of funds, investors should ask what role each holding plays and whether it adds something genuinely different,” said Lipski.
Does the size of your portfolio impact the number of funds you should hold?
There’s no real reason why the size of your portfolio should dictate the number of funds you hold. Regardless of size, your portfolio is likely to be allocated based on percentages of the total. Your risk appetite and other factors will dictate what percentage of the whole you allocate to different sectors and asset classes.
“The size of the portfolio matters less than its overall asset allocation and the role of each fund. A large portfolio does not automatically need more funds,” said Lipski. “Someone with a relatively small portfolio can obtain broad diversification through one multi asset fund, while investors who want greater control over their asset allocation may choose several funds.
“If a fund represents less than around 2% of your portfolio, it is worth asking whether it is large enough to make a meaningful difference to overall returns or risk,” he added. “There may be good reasons for a small specialist allocation, but very small holdings can otherwise add complexity without materially changing the portfolio.”
