How many funds is enough? Vanguard Target Retirement 2055 (VFFVX) is a fund of funds that consists of just four funds: one for U.S stocks, U.S. bonds, international stocks, and international bonds. In contrast, MassMutual RetireSMART 2055 (MMWAX) has 35 funds, of which 17 are focused on U.S. stocks. There is a separate fund for small-cap exposure, small-cap value, and small-cap growth. Which approach is better--a single fund to cover an entire asset class or separate funds that carve up and target specific segments of an asset class? A truly passive approach would seem to favor the former.
For taxable accounts, a broad index fund is a better option for investors building a complete allocation to U.S. equities compared with using separate size segment funds. Because a broad fund holds both large- and small-cap stocks, it is not forced to buy or sell as stocks migrate into a different market-cap range. For example, compare an investor holding a Russell 3000 Index fund versus separate funds for the Russell 1000 and Russell 2000 indexes. If a small-cap stock appreciates in price, it will be sold by the small-cap fund and purchased by the large-cap fund. But the Russell 3000 fund does not need to make any trades, as that same stock would just fluctuate up or down in size but stay in the same index. This low turnover can promote tax efficiency. Even for investors in tax-deferred accounts, holding a broad index fund should have lower trading costs.
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Michael Rawson does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.