How Many Mutual Funds Should You Have in Your Investment Portfolio?

Time to take an inventory of your mutual funds. How many are there? What are their investment styles? Is your mutual fund portfolio cluttered just like your closet? Have you owned some funds so long that you have forgotten why you bought them? Are there some funds on the top shelf, way in the back of your financial closet you haven't even looked at in a while?

Adding a new fund to your portfolio is far easier than reorganizing your fund portfolio and discarding inappropriate, redundant, or simply poor-performing funds. The answer to the question of how many mutual funds you should have in your portfolio is not just a number. But if you have many more than eight mutual funds in your closet, chances are you need to do some serious portfolio cleaning. Here's why.

First, in order to be well-diversified, your mutual fund portfolio should be invested in domestic and foreign stock mutual funds and in fixed-income funds or income fund equivalents. Within the domestic stock market, your funds should cover large stocks, small stocks, and stocks in-between.

Foreign investments should cover established firms in industrialized countries and stocks of countries that would be considered emerging markets. While geographic diversification domestically is relatively unimportant, diversification by region for foreign investments is. Representation in Europe for a large stock international fund is important and investments in Latin America and the Pacific Rim are crucial for an emerging stock fund. Global funds that invest domestically and abroad sound like a one-fund answer, but it is too much geography for one portfolio manager to cover and global funds tend to change domestic/foreign portfolio weights as world conditions change, neutralizing some diversification benefits.

The Count

Let's stop and take a count: one large stock domestic fund, one small stock domestic fund, one international large stock fund, one emerging market stock fund—so far, four funds. Have we missed the mid-sized domestic stocks? Well, check your large-cap stock fund and your small-cap stock fund to see what they include. Usually, large stock funds leak down into the mid-size range and small stock funds push up into the mid-size range. If not, add a mid-size fund to avoid any portfolio gaps. Now we may be up to five, all of which are stock funds at this point.

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