Investors are regularly told that diversification is the key to a successful long-term investment strategy.
A diversified portfolio will have exposure to assets such as bonds, cash, commodities and property as well as equities. The idea is that this will help to ride out the ups and downs because the performances of other assets are less tied to stock market movements. After all, no single asset class can be the top performer all the time and in all economic conditions.
It is also important to diversify your investment styles, so having a mix of value stocks, such as financial firms and energy companies which are “undervalued” (firms that are profitable but whose shares are cheap compared with similar companies), and growth stocks, which are expensive but fast-growing, can be a good idea. Growth stocks, such as Microsoft and Apple, have been in favour for much of the past decade when low interest rates helped to fuel growth, but value stocks have started to perform better as interest rates rise.
Doing all this could mean you end up with a long list of investments though, so what is the right number of funds and stocks to hold in your Isa?
Above 20 and most financial advisors would say it becomes difficult to monitor.
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Some fund platforms hold around ten holdings in each of their model portfolios, whether shares or funds, which they feel is the minimum required to produce a sensibly diversified portfolio while at the same time spreading risk.
Owning too few means that your money perhaps isn’t diversified enough, but if you go too far the other way, it can be overkill.
One reason to avoid buying up too many funds is that you might end up duplicating stocks and sectors. If, for example, you invest in 20 different funds, you could be holding as many as 1,000 different stocks.
Hannah Edwards, the owner of the wealth management firm Eva Capital Management, said: “This can be a poor decision, if you accumulate lots of expensive actively managed funds (those which are run by a human manager who selects which stocks to invest in) who all have the same or similar top ten holdings.
“By duplicating many of your investments and paying out fees for each fund, inevitably you’ll end up with a portfolio that becomes an overpriced tracker (a fund that uses algorithms to replicate the holdings of an index such as the FTSE 100). You need to ensure that you have the right blend of investment styles, which means that the holdings in your chosen funds are diversified.”
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The number of funds you choose differs according to whether you’re just starting out investing, or if you’re an experienced investor — or somewhere in between.
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Maike Currie, the investment director at the fund manager Fidelity International, said that a rule of thumb for a beginner is to start with just one fund.
“If you only have a small pot of money, holding too many funds in the name of diversification can get pricey,” she says. “Perhaps consider holding a passive fund that invests globally, such as the Fidelity Global Quality Income ETF or Vanguard FTSE All-World ETF, to ensure diversification while keeping costs low.
“For an experienced investor, with a large portfolio of more than £100,000, choose anywhere between 10 and 15 funds across different asset classes. Advisers will typically recommend that your minimum fund size is at least 5 per cent of your portfolio. It can also be prudent to limit exposure to any single fund to no more than 15 per cent of your overall portfolio.”
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Investors can check on any overlapping in a portfolio by using a tool on an investment platform. At AJ Bell Youinvest it’s called Portfolio X-Ray while Hargreaves Lansdown call it Portfolio Analysis.
Such tools will show you a breakdown of funds, sectors and asset classes you hold so that you can see clearly if you are leaning too much towards one geographic area or type of investment.
Currie said: “If you are still struggling with how many funds to hold, you could take a ‘one-stop shop’ approach with a multi-asset fund such as the Fidelity Select 50 Balanced Fund. This holds a range of funds in a single fund, so it works a bit like an instant diversified portfolio.”
