Collectives editor Kyle Caldwell looks at this investing dilemma.
A common question I’ve been asked over the years is how many funds to invest in. I am sure this is something many ISA investors will be pondering in the run-up to tax year end.
However, as is common with other investment-related questions, there’s no ‘magic number’ of funds investors should aim for.
How much 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.
For larger pot sizes, and as your portfolio (hopefully) grows, you can create your own diversified portfolio by selecting funds from different asset classes, regions, company sizes, and investment styles (such as growth and value).
However, there’s a pitfall to avoid – buying too many funds or investment trusts. If you treat funds like sweets and have too many, you risk ending up 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 UK funds, you could potentially end up owning hundreds of different companies. That makes it harder to beat the stock market because your portfolio ends up replicating 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). Therefore, it is important to ensure that each fund is bringing something unique to the party in terms of how it invests and what it is investing in.
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If you own two or more funds that invest in the same region and have the same investment style, then consider doing some pruning. A quick way to check for overlap is to take a look at the respective top 10 holdings – ideally I’d want to see less than half being the same.
It also makes sense to diversify by fund firms, as some follow a particular investment style that could go out of fashion.
In addition, investors need to weigh up how much time they have. 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. Among the things to check a couple of times a year is whether the fund manager and strategy is the same as it was when you first bought the fund or trust.
For me, it makes sense to invest in a manageable number of different fund types to reduce risk, while at the same time avoiding diversifying too much. If you have more than 20 funds, it would be a good idea to review them and ensure each one is pulling its weight in terms of performance, and that they are sufficiently different from one another.
- Watch our Fundamentals video: what is a passive fund and is this the best way to invest?
- Watch our Fundamentals video: what does a fund manager do?
- Eight easy ways to boost your ISA returns
- My first four years as an ISA investor
Another thing to bear in mind is whether your fund holdings are big enough to contribute to the overall returns. If you have funds that are less than 2% of your portfolio, then it is perhaps worth cutting back as they won’t be adding much value.
For those dipping their toe into the stock market for the first time, as mentioned above, 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 Quick-start range, aimed at beginner investors, endorses six multi-asset funds that we believe stand out from the crowd. Three of the funds are actively managed by BMO’s fund managers and the other three are passively managed low-cost funds from Vanguard that follow the performance of the market.
In interactive investor’s model portfolios between 10 and 12 funds are held, covering all the major asset classes, such as shares, bonds and commercial property.
These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.
Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.
Please remember, investment value can go up or down and you could get back less than you invest. If you’re in any doubt about the suitability of a stocks & shares ISA, you should seek independent financial advice. The tax treatment of this product depends on your individual circumstances and may change in future. If you are uncertain about the tax treatment of the product you should contact HMRC or seek independent tax advice.
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