Question: How many mutual or exchange-traded funds should I own?
March 1, 2014 by Editor, InvestingForMe
When it comes to investing, many average Canadians get confused by this question. We’re often told that we need to diversify our investments if we want to lower our investment risks, but how much diversification do you need?
The answer will depend on your investment goals, your chosen investment style, and your desired investment mix.
To make that question easier to answer, I’m going to make the following assumptions:
- You’re among the 35% of Canadians that invests their savings in stocks or equity investment funds, and like the majority (68%) of those stock market investors; you have no interest in investing outside Canada.
- You’re investing for long-term goals like your retirement.
When it comes to diversification a number of past studies have demonstrated that if you’re investing for growth, buying shares of large companies, and you want to maximize your returns and minimize the volatility of your investment portfolio, you will need to buy and hold shares of between 12 to 20 individual companies.
So, if you’re like the majority of Canadians, investing for growth means investing with a buy and hold, conservative, approach and you don’t care to invest your savings outside of Canada. And if this rings true for you then you may only need to own one mutual fund or exchange traded fund (ETF).
Here are a couple of great popular ETF options that would give you more than enough diversification as each of these invests in the 60 largest Canadian companies that trade on the Toronto Stock Exchange (TSX):
Couple of more take-home thoughts
Here are a few more helpful points to keep in mind when considering how many funds an average Canadian investor needs to buy:
- Research done by Standards & Poors has determined that funds investing with an Equal-Weight structure (where the fund invests the same amount of money in each individual company) outperform those funds that use a Market-Capitalization structure (where the fund invests different amounts of money in each individual company).
- When looking at stock market investment funds, just because a fund manager invests in hundreds of individual companies doesn’t make it a better investment fund to own. Sometimes a fund can diversify too much. For example, I challenge you to name 5 companies you think would make great investments. Go on name them! Now name 10. Now 20. And how about 25? I bet you are struggling to name 20 companies. So think about it. If a fund manager is going to buy a hundred or more companies, how many are truly great and how many are going to be only mediocre or worse?
- If you own two or more investment funds, answer me this – how much of your money is invested in bank stocks? How much is invested in gold, oil, pipelines, industrials, etc.? Get my point? You likely have no idea and chances are your advisor doesn't either! Calculating your overall asset allocation becomes increasingly difficult as you increase the number of investment funds in your portfolio. Having too much of your savings in one stock market sector is never a problem when stock markets are rising. But when stock markets decide to fall, then it can be a nasty problem.
- Look for investment funds that have a Portfolio Turnover Ratio (PTR) that matches your investment approach – i.e. a low PTR if you’re a conservative investor and a high PTR if you’re more aggressive.
So when trying to decide how many investment funds you should buy, you should first have a clear understanding of your investment goals and the investment mix you need to maintain to reach your goals. Depending on your objectives, owning only one fund may be all you need.
(Published by Troy Media)