Diversification Beyond Classes
When investing in mutual funds the most important factor to your long term success is diversification. Diversification reduces investment risk by spreading your risk across hundreds of stocks. Remember when building your investment portfolio that you should not only diversify across classes (Large cap, Mid Cap) but you should also pay close attention to the companies in which the fund invests in, and a great service to review and compare mutual funds is Morning Star. When reviewing your funds analyze their top 25 holdings and compare it to other funds you are interested in. If there are more than 3 of the same companies in the funds top 10, then the funds are too similar and, regardless of class, would not constitute a true diversified portfolio.
For example, we’ll take two funds, Amerifunds Washington Mutual A (AWSHX) and American Century Select Inv (TWCIX). While both funds are classified differently, large value and large growth, they both hold JP Morgan as one of their top 3 companies. This means that if one fund underperforms it is likely that the other will show decline as well.
Use this example as a reminder not only to diversify your classes of funds but make sure the companies are diversified as well.
