How many funds should I own in my stocks and shares ISA?

A common question I’ve been asked over the years by interactive investor customers is how many funds to invest in. It’s something that many investors looking to make the most of the annual £20,000 ISA allowance will be pondering in the run-up to tax year end.

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However, in common with other investment-related questions, there’s not a clear-cut answer, and there’s not a magic number of funds that investors should aim for.

But there are some things to consider that can help investors decide how many funds to own. However, it’s important not to overdo it and have a huge number of investments.

What type of investor are you?

How much money you have to invest is one factor. If you’re making your first foray into the stock market and have £1,000 to invest, then one fund makes sense. You could buy a one-stop shop multi-asset fund to obtain instant diversification, as such funds buy both shares and bonds.

Those who don’t have the time or inclination to keep on top of investments could look to hassle-free options, such as interactive investor’s Managed ISA range, Vanguard LifeStrategy, BlackRock MyMap and Legal & General Investment Management’s Multi-Index funds.

These fund ranges are low cost, providing exposure to tracker funds that follow the ups and downs of global stock and bond markets. These funds are highly diversified and own thousands of shares and bonds. Each range has different risk levels, with ‘adventurous’ funds holding a greater proportion in shares.

Start small then add more funds as portfolio grows

For investors who are happy to pick their own funds rather than going down the multi-asset route, consider starting with one or two and expanding into other areas as your portfolio grows.

Investors can create their own diversified portfolio by selecting funds investing in different asset classes (shares, bonds and other areas, such as commodities) regions, and company sizes. There are also different investment styles to consider, such as growth, income and value.

As already mentioned, there’s no magic number to aim for, but a highly diversified portfolio can be achieved by holding 10 to 15 funds. Some investors may feel they can attain this with fewer than 10 funds, while others may wish to own more. Ultimately, it’s a personal decision.

A strategy to consider when building a portfolio is the core/satellite approach, where the split is either 70%/80% for core holdings and 30%/20% for satellite holdings.

Core holdings are those that investors can tuck away with confidence for the long term, such as funds investing in global or developed markets, including the UK. Whereas satellite holdings are more adventurous, and examples include funds investing in Asia Pacific, emerging markets, smaller companies or those specialising in a theme or sector. Such holdings require more attention, as performance won’t be as smooth.

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Avoid overdoing it

Avoid buying too many funds or investment trusts. If you treat funds like sweets and have too many, you risk doing more damage than good through over-diversifying and unwittingly replicating the market. This is known as “diworsification”.

For example, if you own half a dozen or more actively managed UK funds attempting to beat the market, you could potentially end up owning hundreds of different companies. That makes it harder to beat the stock market because your portfolio ends up looking like it.

If you want to invest in hundreds of UK shares, this can be done much more cheaply through a passive fund – either an index tracker or exchange-traded fund (ETF). It’s important to ensure that each fund is bringing something unique to the party in terms of how it invests and what it’s investing in.

For those who own a couple of active funds investing in the same region with the same investment style, consider doing some pruning.

A quick way to check for overlap is to look at the respective top 10 holdings and sector weightings. When it comes to global funds, study country weightings too. A large amount of overlap could indicate that the funds are too similar.

Also examine performance. If a performance line chart looks similar over different time periods, this could indicate that the funds are not providing sufficiently different exposure.

In addition, ensure the fund is taking enough active bets versus its benchmark. If the fund manager is not investing enough away from the index - such as the FTSE All-Share for UK funds - that leaves less scope for the fund to outperform and justify its higher yearly fee versus an index fund or ETF.

It also makes sense to diversify by fund firm, as some follow a particular investment style that could go out of fashion. Baillie Gifford, for example, has a growth-focused approach to investing.

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Also look under the bonnet with index funds and ETFs

For those who prefer to own passive funds, it’s important to look under the bonnet and understand what you are investing in. For example, some global index funds and ETFs only provide exposure to developed markets, whereas others include emerging markets.

Some index funds and ETFs investing in a certain region or sector aim to mirror the performance of the same index, such as the MSCI World index. Therefore, owning more than one index fund or ETF tracking that index will be doubling up on the same exposure.

Also consider whether you need both a global tracker fund and a US tracker fund. A global fund provides a high amount of exposure to the US, typically over 70%. A global index fund or ETF will also provide plenty of exposure to the US technology giants, the so-called Magnificent Seven. Those seven stocks, Microsoft Corp (NASDAQ:MSFT), NVIDIA Corp (NASDAQ:NVDA), Amazon.com Inc (NASDAQ:AMZN), Alphabet Inc Class A (NASDAQ:GOOGL), Apple Inc (NASDAQ:AAPL), Meta Platforms Inc Class A (NASDAQ:META) and Tesla Inc (NASDAQ:TSLA), currently account for 25% of a global tracker.

Question of time

Something else that investors need to weigh up is how much time they are willing to dedicate to managing their investments. The more funds you buy, the harder it is to keep on top of how they are performing and whether changes need to be made.

Things to check a couple of times a year include whether the fund or investment trust manager and strategy remain the same as when you first invested. 

A manager change – particularly if there’s evidence of longstanding succession planning – is not necessarily a reason to sell. But if a fund’s no longer doing what you want it to, it’s probably time to hit the sell button. For example, if you bought it for income purposes and it’s no longer paying dividends.

Key person risk is an important thing to assess. Has one manager been highly influential by calling all the shots, or has it been more of a team approach? If it’s the former, then a manager jumping ship to another fund firm or retiring, is arguably more of a blow.

Another problem with having too many funds is that you can end up with a large tail of small holdings that – even if they perform well – won’t add much value to your overall returns.

Funds that are less than 2% of your overall portfolio are worth addressing. Ask yourself why you picked them and whether they are fulfilling their role in your portfolio. Consider whether you would buy more, thus making it a more meaningful position. Alternatively, if you have lost faith, it could be time to move on.

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For me, it makes sense to invest in a manageable number of funds to reduce risk, while avoiding diversifying too much. If you have more than 20 funds, it would be a good idea to review them to make sure they are sufficiently different, and to check that each one’s pulling its weight in terms of performance.

For those dipping their toe into the stock market for the first time, a multi-asset fund is a sensible starting point. Such funds give your money ample opportunity to grow, while also guarding against severe short-term losses.

At interactive investor, our Managed ISA is a range of 10 portfolios that cater to different risk levels. There’s also the option of investing sustainably. Each portfolio holds between 10 and 20 funds. There’s also our Managed Portfolios for self-invested personal pensions (SIPPs).

Our Quick-start Funds are another option to consider as part of your wider research. This ii-endorsed range is made up of six multi-asset funds. Three are actively managed by Royal London and three are passively managed low-cost funds from Vanguard that follow the performance of the market.