One of the most common questions new investors ask is: ‘how many funds should I own?’ It’s a question that was posed to us recently, and so we thought we’d dedicate an article to answering it.
Annoyingly, there isn’t one simple answer or magic number. It depends on a lot of factors, but mainly on how much you’re investing and what you’re investing in. For simplicity’s sake we’ll leave aside investing directly in stocks, and look at someone who has their money just in funds and investment trusts.
Why can’t I just own one fund?
First, let’s look at why you wouldn’t want to own just one fund. Generally you want your investments to be diversified, which means spreading your money between different stocks and types of investment.
So at its extreme, a very undiversified portfolio would hold just one stock, and a very over-diversified portfolio would hold 40 funds. What you’re trying to do is make sure that if one fund doesn’t do very well, it doesn’t cause your whole portfolio to tank.
Funds can underperform, fund managers can be hit by a bus, markets can fall – so you want to make sure that if one of those things happens, it doesn’t have a devastating impact on your investment pot.
Why wouldn’t I own 40 funds?
Some people might read the above and think, ‘okay, well I’ll just buy loads of funds and then I’m covered’, but there are downsides to this too.
The first is charges. Each time you buy and sell a fund you’ll usually pay a fee. Assuming your fee is £1.50 each time, if you buy 40 funds that’s going to cost you £60 before you even get started. If you’re investing monthly and buying this number of funds each month, that’s going to really eat into your returns.
Second, it’s time consuming to monitor all those funds. You’ll want to keep track of any funds you buy: how they’re performing, what fund managers are saying about them etc. That’s doable for a handful of funds, but pretty much a full-time job for 50 funds.
And finally, you’ll diversify away any of your gains. This sounds a bit complicated but essentially it means that if a fund does particularly well, it’s going to have a minimal impact on your portfolio if it only accounts for a tiny proportion of it. What’s more, if you’re buying funds you’ll probably end up owning the same companies multiple times across different funds, which isn’t very useful for your returns.
So, what’s the magic number?
There isn’t a strict rule, but between five and 10 funds is usually a good idea. That lets you allocate money to different types of funds and markets without doubling up too much. It’s also a manageable number to monitor and won’t cost you too much in trading fees.
But, size does matter. If you’re just starting out with investing and have £1,000 in your account, owning 10 funds is probably going to be too many. You’ll be paying a lot in trading costs, relative to your total investments, and it will probably feel overwhelming to pick 10 funds straight away. It’s fine to have a portfolio that’s a work-in-progress, with fewer funds to start with. You can have a rough plan of what you want your portfolio to look like in a year or two’s time, and work towards that. Nothing is perfect on day one.
Equally, if you’ve been investing for a long time and have a large portfolio built up, you could easily have more than 10 funds. As long as each one is serving a specific purpose and there isn’t much overlap, that’s okay.
Is there a clever trick to avoid all this?
There actually is. If the funds you buy are already very well diversified, it takes some of the hard work out of it for you. Some funds are intended to be a one-stop-shop. Even if you only own one of these funds and nothing else, your money is still spread across lots of different companies, countries and asset classes.
The likes of Vanguard LifeStrategy (or the own-brand version that most platforms have) let you pick an allocation to the stock market, with the rest being invested in bonds. For example, the LifeStrategy 60 fund has 60% in company shares and the rest in bonds. It achieves this by investing in tracker funds, which mimic the performance of big market indexes, such as the FTSE 100 or global markets.
Another option is to just do this yourself. So, you could buy an index tracker of a global index and effectively get access to thousands of companies in one go – a common index used is the MSCI World. Something like the Fidelity Index World does this, comes at a low cost and effectively gives you a little piece of a lot of global companies.
You could use broad indexes like this as the base for your portfolio, then add other funds on top. The broad index trackers can give you diversification, then you can add funds for specific allocations you want – an ESG fund or a technology fund, for example. This could also be a good approach if you’re just starting out and building up your portfolio, as it means you can own a couple of funds but still be diversified.
Remember that the value of investments can change, and you could lose money as well as make it. Past performance is not a guide to future performance.
These articles are for information purposes only and are not a personal recommendation or advice.
