Personal Finance How too many mutual funds can be a mistake

By Stan Choe

AP Business Writer

NEW YORK (AP) -- Everyone knows it's good to diversify. By splitting savings between stocks, bonds and cash, investors can minimize their risk.

Enter target-date mutual funds, which handle diversification duties for investors. The pitch: Invest in just one standalone fund, and the portfolio will shift money over time into more conservative investments as the accountholder approaches retirement age.

But there can be too much of a good thing.

A small number of investors with a target-date fund are mixing them with seven or even more additional mutual funds.

Vanguard found 6 percent of investors in 401(k) and other defined-contribution retirement plans were such extreme diversifiers. The problem with owning so many funds is the investors may just be duplicating holdings already in their target-date fund.

They also may be paying higher costs for these extra funds, hoping the professional stock pickers can help them beat the market. But when combining so many different funds into one portfolio, the resulting whole acts more like an index fund. So investors may be increasing their costs without much benefit.

Such excessive diversification is rare, but it's not uncommon for most investors to mix their target-date retirement funds with one or two others, according to Vanguard's research.

Such moderate mixing is fine, as long as investors know they may be adding more risk than the target-date fund's managers suggest.

At T. Rowe Price, for example, the investment advisory committee suggests those who are 15 years away from their retirement date keep 75 percent of retirement savings in stocks. With five years to go, that should drop to 63 percent stocks, in hopes of lowering risk.

T. Rowe Price builds its target-date retirement funds to downshift its stock holdings according to that timeline.

Published: Thu, Oct 21, 2010