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Walter Updegrave, retired senior editor at MONEY magazine, has written an important article about the number of funds needed for adequate diversification. These are excerpts:
How many funds do you really need to diversify?
"When you're building a portfolio for retirement -- or any other purpose, for that matter -- your goal shouldn't be to load up with as many different types of investments as you can (although you can certainly get that impression given the constant flow of new and often gimmicky funds and ETFs that financial services funds churn out)."
"I prefer the total stock market fund approach I described above rather than separate funds for large-, mid- and small-cap stocks because it keeps things simpler and requires less monitoring and managing of one's portfolio."
"If you start throwing yet more funds into your current mix, I'd say you run the risk of turning your portfolio into an unwieldy mishmash of overlapping holdings that don't work together as a coherent whole. In short, you stand a good chance of "di-worse-ifying" rather than diversifying."
"Your next step is to make sure that your stock and bond holdings generally reflect the makeup of the stock and bond market overall. For example, large-company stocks account for roughly 70% of total stock market value, while midcaps and small-caps represent about 20% and 10% respectively. Your holdings don't have to mirror these percentages exactly. But if you want a truly diversified portfolio with a risk profile largely in line with that of the market overall, then you don't want your portfolio's proportions to be too far off either."
"Don't assume that more is better when it comes to funds."
is the master key to financial success." -- Jack Bogle
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The minimum number is one. A correctly-chosen Balanced, Target Retirement, or LifeStrategy fund can provide all the diversification one needs.
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I think I've said this same thing in my signature for a while now. great minds think alike
-- Don't mistake more funds for more diversity: Total Int'l + Total Market = 7k to 10k stocks -- | -- Market return does NOT = average nor 50th percentile, rather 80-90th percentile long term ---
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Sounds good in theory until the reality that his TSP doesn't have a total US stock fund but does have a large cap and small cap index options and his international is just EAFE (large cap developed) with no small cap or EM and on the plus side the fixed income fund is superior to just about anything including TBM. Meanwhile her only decent 401-K stock fund is S&P 500 institutional, zero acceptable small cap or international funds and the only two bond funds without outlandish ER's is an odd duo of Vanguard short-term bond index and an intermediate term active US bond fund. So cobble all those together in some logical fashion, pick up EM and international small cap in taxable and IRA's and it's off to the races. And now that 2nd and 3rd generation ultra-low cost index ETF's are out you aren't going to keep buying EEM, but darn you have a huge capital gains liability in EEM so you get some tax-harvesting EM pairs to whittle away at that during EM downturns. Diversified as well as the 3-fund approach? You bet - maybe even better. 2 or 3 funds? Ah......no.
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According to William F. Sharpe, the answer should be one fund, but that fund doesn't exist–not even at Vanguard. So, currently the answer is four funds: two US (bonds, stocks) and two non-US (bonds, stocks).
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