I'm 35 and have been contributing to my work's 401k for years since they match my contributions up to a point. I'm going to start a Roth IRA, is there an ideal number of mutual funds that I should be looking at? Should I consider investing in multiple target date funds?
The "Golden Number" of mutual funds you should invest in is zero.
The mutual fund is an inferior product utilizing the cutting edge of post-Depression Era technology (the Investment Company Act of 1940 created the rules).
The few remaining mutual funds I will use have active managers that I trust through mutipe market cycles because they can "go anywhere" - when these managers inevitably launch new funds in the active ETF wrapper, I fully expect to convert these holdings.
Eddie, while there isn’t a perfect number of funds for a portfolio, you can have too few if the funds are specialized, and you can have too many if there is too much overlap between them.
Some investors are able to achieve the right balance in their portfolio with one fund, maybe a target date fund as you suggested, because it is broadly diversified. Others may have four to seven funds if the funds are based on broad asset classes like U.S. Stocks or International Bonds. Still other investors may need a dozen or more funds to properly diversify their portfolio if the funds they select are really specialized. The more specialized the funds in your portfolio, the more funds you may need to own to reduce your risk and give you the balance you are looking for.
Take an investor who purchases a fund which is focused on investing in small growth stocks based in the U.S. This may be a great long-term investment, but the investor probably wouldn’t want to invest everything they have in that fund because of the risks involved. This fund may make up a small percentage of their overall portfolio, and they would have to fill the void with other funds. Another investor could invest everything in one target date fund, and be perfectly satisfied.
You could invest in multiple target date funds, but by their very nature, they are trying to provide a one-stop investment for investors. You would really need to determine what the differences are between the different funds to determine if it makes sense to have more than one in your portfolio.
One final note, the single greatest thing you can understand about any fund is its strategy. If you understand what the manager is trying to accomplish, it will go a long way toward helping you know whether or not it may be a good fit for you within your portfolio, and whether or not it overlaps with other investments you already own.
Eddie, Travis mentioned multiple target date funds, which are a simple, effective solution. In line with this thinking, you can consider one-stop-shop solutions from e.g. Vanguard which do not adjust over time but retain a general bonds/stocks/cash allocation. The Vanguard LifeStrategy mutual funds series is an excellent, low-cost example of a mutual funds line-up that has just about everything you need in one investment: cash/various equity positions/various bond positions. The LifeStrategy lineup costs less than 0.2% per year in underlying expenses and has a strategic core (e.g. 55% stocks, 40% bonds, 5% cash) that changes a little according to tactical shifts that are meant to take advantage of overvalued/undervalued assets.
Hi Eddie, My answer to your question is that it is not how many funds you invest in, rather you need exposure to different asset classes i.e. large cap, small, value international etc. Depending your 401k options you may be able to do so with a few funds or it may take many funds to accomplish this goal. If you have target date or lifestyle funds offered within the plan they often cover a wide variety of asset classes.
To see a wide array of asset classes go to dfaus.com then go to the strategies tab. Once there the last choice underneath that tab is performance. Now look at the component fund heading (U.S. equity, non US equity, emerging markets, Real estate component headings) Two things may stand out, first there are probably a few asset classes you have never heard of or even considered and there have been some pretty good 10 year returns in most of the stock asset classes. Diversification actual worked pretty well! Words to the wise, Eddie, do not make an assumption that high returns in an asset class will continue, so stay diversified.
As for any young person, Eddie, how much you save id much more important than any investment you can pick. Returns are the X part of my business and they are not within are control. Saving an adequate amount of money is.
As already discussed, asset diversification is the key. I think if you go the target date route then one fund ought to do it. When I build portfolios for clients, I tend to use about 15 funds. Generally there are about 2 or 3 from alternative assets, 5-6 from fixed income, 5-6 from equities and 1 long/short fund. I use this many because I want to employ a best of breed mix of active management and index funds. Of course, as a fee only independent, I can choose among 14,000 different funds and ETFs. In a 401k you might be severely limited and find that among the options you have your best bet could be a small handful of index funds. If you go with a non-index fund, try to do some research on the fund to make sure that management has earned the extra fee they charge. Not that many do.
Something to be aware of is if you go with a target date retirement fund, there might be certain portions missing in the fund that you must have exposure to. For example, the all in one fund might likely be missing areas like small cap value/growth and mid cap value/growth. There might be a lack of non-US bond exposure too. It pays to get a detailed analysis of the target fund and then layer in a few other funds to make up for any holes in that portfolio.
To an extent, I would argue against all of these answers because I think it's even simpler. The critical investment decision is simply the mix of Stocks, Bonds and Cash. ( Have we lost sight of the Brinson hood beebower study?) If you spoke through a telephone wire you would sound like Charlie Brown ( wha wha wha) unless there is a "Smoothing Kernel" which removes 90% of the noise so the communication is clear. Most of the answers above include a lot of "noise" ETF's vs Mutual Funds, Big Cap Vs.Small Cap. Target Date et cetera because they account for ONLY ABOUT 10% OF YOUR RESULT. 90% comes from the basic decision: What is your mix of stocks bonds and cash? And are you well diversified? ( And of course.... are you investing enough to reach your goals?) Have a great day, Evan.