The Lone-Fund Portfolio

One may be the loneliest number, but for skittish investors it may provide some much-needed solace.

We're talking, of course, about a one-fund portfolio.

You already know that owning too many mutual funds is at best redundant, at worst a costly drag on your returns. There's virtually no reason to own more than eight funds, and many investors need far fewer.

"Some smaller investors -- such as those with portfolios less than $200,000 -- could certainly do with just one equity and one bond fund," says Ed Osborn, a principal with the portfolio management firm Bingham, Osborn & Scarborough.

But investors tempted to make do with just one or two funds should know the risks.

"For the majority of investors, it makes much more sense to split their assets appropriately," says Larry Swedroe, a financial planner and author of Rational Investing in Irrational Times. Fixed-income funds should be in a tax-deferred account, and equities should be held in a taxable account."

Bonds that pay out taxable interest are best held in a tax-deferred account (like an IRA) so investors avoid the tax until they withdraw from the account. Holding equities in a tax-deferred account, though, means you give up the ability to pay the lower capital gains tax rate when you sell your holdings, since all tax is deferred until withdrawal, at which point it's all taxed at the higher ordinary income tax rate, rather than the capital gains tax rate.

But for investors who have their entire portfolio in one (presumably retirement) account and really can't bear the thought of taking an active role in determining their investments, some of these funds might help.

"The biggest determining factor as to whether an investor should go into one of these funds is how much time they want to dedicate to making investment decisions," says Morningstar Mutual Fund Analyst Langdon Healy. "That's the general profile for these funds."