- The Washington Times - Thursday, December 26, 2002

Amid a grueling three-year bear market, investors have been reminded constantly of the need to diversify their financial portfolios. But analysts worry that investors may respond by choosing too many mutual funds, a strategy that can be equally hazardous.
"The tendency is to hold more funds rather than fewer," said Catherine Gordon, head of Vanguard Group's investment counseling and research department. "But people shouldn't get overconfident just because they have a large number of funds."
Financial planners say true diversification means investing not only in different companies, but different kinds including small and large capitalization, growth and value, domestic and international. It also involves investing in bonds, and perhaps real estate or precious metals.
But some investors find false comfort in having a bulky portfolio with holdings that too often are duplicated, or overconcentrated in the same kinds of investments. The resulting problems can range from unnecessary expenses and subpar performance to excessive paperwork.
"You can have a problem of way too much overlap," said Emily Hall, senior mutual fund analyst at Chicago-based Morningstar. While having too few funds can lead to an overly volatile portfolio, having too many can unduly weaken an investor's return, she says.
She explained that diversification reduces risk by minimizing losses if one sector, such as technology, does particularly poorly. Too much diversification waters down returns and can cause a portfolio to mimic, instead of outperform, the overall market.
How many funds is too many? Planners say it varies, although many suggest investors scrutinize their portfolios for duplication if they own 10 or more funds.
One common misstep can happen when investors own funds offered by different fund companies. The funds may not be so diversified if the managers are picking the same types of stocks.
"You can certainly make it so complicated that you have a tough time, keeping track," said Herbert Karl Daroff, a certified financial planner in Boston.
Indeed, owning too many funds places a greater burden on investors who have more paperwork to sift through, while piling up unnecessary expenses. That is because some analysts believe that a wide collection of funds isn't much different from a broad index fund, which has lower costs.
Financial planners advise investors to check for duplication among different funds by checking prospectuses, which list the securities held, or Web sites such as www.morningstar.com, which help investors break down holdings by sector, asset class and other characteristics.
They say now may be a good time to slim down a cluttered portfolio since in the current bear market, holdings that are sold are likely to be losers, thus minimizing tax consequences.
Vanguard's Miss Gordon also suggests that for investors just starting out or using tax-sheltered retirement accounts, it might be easiest to pick three core index holdings including a broadly diversified U.S. fund, international fund and bond fund. They then can add "satellite" actively managed funds that add exposure to particular sectors.
Investors who already have substantial holdings, on the other hand, may want to take smaller steps to eliminate duplication and increase exposure to different types.

ASSOCIATED PRESS

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