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How Many Fund Holdings Is Too Many?

You might be surprised at just how low you can go.

Here's a question that seems simple but, like many investment topics, can be tricky to answer: How many funds should you own in a given account in your investment portfolio?

The bottom line is that there's no single number that's right for everyone. If you want to keep things simple, you can go with as few as one (think target-date funds), three, or five funds that cover the core asset classes. (You won't be alone if you go for the Marie Kondo approach to your mutual fund investments. According to the Investment Company Institute's 2018 "Profile of Mutual Fund Shareholders," more than half of U.S. households own four or fewer funds--likely owing to the predominance of target-date funds.)

Recommended Ranges My group at Morningstar provides outsourced fiduciary services to retirement-plan clients. We typically offer "core," "standard," and "expanded" lineup options, geared toward the specific demographic characteristics and preferences of a given plan sponsor (arrived at through questionnaires). A core lineup offers a more limited but still diversified set of six asset classes, usually in cases where a work force is deemed to have less investment knowledge and lower risk tolerance or capacity. Standard and expanded lineups will offer more choices, extended to a greater number of diversifying satellite asset classes for employee bases with greater investment knowledge and higher risk tolerances (among other factors considered, such as industry-specific exposures or preferences of the workers).

As an investor, you might think about your own approach in similar terms: Do I have the interest, knowledge, and greater tolerance for the ups and downs of specialized asset classes to support a more expansive set of funds in my portfolio? Or should I content myself with a more self-contained list?

When creating broader menus of funds for retirement-plan sponsors to choose from, we offer firms the ability to select up to eight noncore asset classes out of a larger available menu of investment types. These include commonly used categories such as high-yield bond, inflation-protected bonds, and REITs, as well as several more-specialized categories. We limit the number of noncore options because we want to minimize the risk of investors tilting their portfolios too heavily toward the satellite asset classes. In all, a plan could have as many as 13 distinct asset classes (excluding cash and target-date funds) and a maximum of 24 funds (because plans can use multiple funds in the core categories). Research has shown that past that number, what psychologists call "choice overload" can set in. (See Sheena Iyengar and Mark Lepper's classic jam study, as well as similar research conducted by Iyengar and colleagues on choice in 401(k) plans.)

We would generally not recommend providing even that much choice to employees. In situations where Morningstar is fully creating the plan lineups (as opposed to an approved menu that plan sponsors can choose from), we typically use around 15-18 distinct categories, with only single fund options for a given category. (Please note that the examples of lineup design here and elsewhere reflect our normal practice but may be modified at times for specific client situations.) And most investors will not need to select from every category. In choosing funds beyond the core categories, it's important to assess whether those asset classes provide true diversification over existing holdings (Christine Benz has recently written several very useful columns in this vein that look at the correlations among asset classes) and whether those asset classes serve a specific investment need that the existing portfolio lacks (such as dedicated inflation protection or higher income), and those needs can vary greatly by investor.

How Low Can You Go? As mentioned, we require plans to include at least six asset classes: domestic large-cap blend, domestic mid-cap, domestic small cap, foreign developed, intermediate-term bond, and cash or a near-cash equivalent. We believe that an investor with exposure to these areas would have adequate diversification, including multiple size U.S. companies (incorporating a home-country bias into the overall allocation), mainstream international exposure, and core fixed income.

But an enterprising investor could reduce that number even further. For instance, the three domestic asset classes could be combined into one all-market index fund, leaving the minimally acceptable number of funds at four. Could one go even lower? Indeed. One might combine all equities into a global index fund like Vanguard Total World Stock ETF VT. And retirement plans, subject to ERISA safe-harbor provisions, are required to include at least one approved "default" option (into which a new employee could be automatically placed), which is either a balanced or target-date fund (most plans these days choose the target-date option). Thus, it would be possible to achieve a baseline level of diversification via a single fund (I'll consider the pros and cons of that approach at greater length in a future column). There are, to be sure, valid reasons for adding noncore asset classes to your portfolio, and I'll explore some of those cases down the road, but for many investors, a simple, uncluttered approach can work perfectly well.

A Note About This Column In this new column, I plan to leverage the work done by the manager selection team at Morningstar (of which I am a member). Our group helps retirement-plan sponsors build fund lineups for their retirement plans, acting in a co-fiduciary role by selecting appropriate asset classes and winnowing down manager lists from large recordkeeper universes. We also work with broker/dealer clients to construct refined fund lists from the thousands of funds that may be available on their platforms, making the process more manageable for their investors. With many years under my belt working in Morningstar's manager research group and on our workplace retirement products, I intend to raise dilemmas and distill concepts that we wrestle with on a daily basis, in ways that I hope will be beneficial to a wide range of investors and readers. Please share your feedback by emailing

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